Dark MTF proliferation may limit buy-side choice

Institutional investors see little value in additional dark multilateral trading facilities and some fear that their execution choices will be reduced by changes made to brokers' internal crossing engines ahead of MiFID II.
By None

Institutional investors see little value in additional dark multilateral trading facilities (MTFs) and some fear that their execution choices will be reduced by changes made to brokers' internal crossing engines ahead of MiFID II.

Earlier this week, Goldman Sachs became the latest broker to announce the launch of an MTF, SIGMA X MTF, which would leverage a portion of the bank's internal liquidity and operate separately from its existing SIGMA internal crossing network.

News of Goldman Sachs' intention to start an MTF closely follows the launch of UBS MTF last month. Nomura's NX dark pool converted into an MTF at the start of 2010. Both Nomura and UBS also run crossing services that operate separately from their MTFs.

But buy-side traders are concerned that a proliferation of dark trading venues would bring few benefits to institutional execution quality.

“There are too many dark MTFs in Europe and I don't think broker-owned MTFs will provide much added value to the buy-side,” said Sören Steinert, head of trading at Germany-based Quoniam Asset Management, which uses dark pools for around 35% of its equity trading. “The fact that brokers will augment their MTFs with internal flow does not make much difference as buy-side traders can already access most of this flow through brokers' existing crossing engines.”

While all three brokers have cited commercial factors, tighter rules around sell-side internalisation are likely following the publication of a consultation by the European Commission (EC) on MiFID. The EC has for feedback on its consultation document by February and draft legislation is expected in Q2 2011.

“I do expect other brokers to follow suit and most are likely to do this as a regulatory hedge. It is better for those brokers to apply for an MTF licence now than wait for the regulations to come in,” said Niki Beattie, managing director at consultancy Market Structure Partners.

The EC consultation suggests a separate definition of broker crossing networks (BCNs) that recognises their differences from public trading venues. BCNs would operate as a subset of organised trading facilities, a new broad category for trading venues outlined in the consultation. The paper also moots the possibility of reclassifying such venues into MTFs should they reach a certain size and lays out tighter definitions for whether existing BCNs should in future be considered as systematic internalisers (SIs) or MTFs.

Jack Vensel, managing director, head of electronic trading at Citi, which operates Citi Match, a crossing network, considers the designations suggested for MTFs, BCNs and SIs in the EC paper to be a positive step.

“I think the EC did a good job in recognising the differences between the various types of venues,” Vensel told theTRADEnews.com. “Brokers now have a decision to make and I think the EC has allowed enough flexibility in their definitions for firms to select the category that best suits their business model.”

Citi as a firm is registered under MiFID as an SI. Trades executed in Citi Match in SI stocks are reported to trade data monitor Markit BOAT as SI transactions but Citi Match itself is not classified under MiFID.

The bank has indicated that it currently has no plans to reclassify Citi Match. Other sell-side firms including Credit Suisse, Barclays Capital, Morgan Stanley, Deutsche Bank and J.P. Morgan declined to comment on their dark pool plans.

The 13 dark MTFs tracked by Thomson Reuters' Equity Market Share Reporter traded €18.61 billion in November, just over 2% of the total value traded in Europe. The top three dark MTFs in Europe in November were Chi-Delta (€5.35 billion), Turquoise's mid-point dark book (€3.17 billion) and buy-side only crossing network Liquidnet (€2.74 billion).

“You only have to look at the volumes on some of the more marginal or recently-launched dark MTFs to see how difficult it is to differentiate in that space,” added Chris Jackson, head of execution sales, EMEA, Citi. “If regulators tried to align the business models of broker dark pools, by forcing them all to become MTFs, you would restrict the diverse range of execution options that the buy-side needs.”

By transforming BCNs into MTFs, the buy-side will also lose the comfort of allowing brokers to have discretion over pool participation. While MTFs are not allowed to restrict access to their platforms, brokers can exclude certain types of flow from their crossing engines.

“Before I use a dark MTF, I need to consider the risk of being picked off by predatory strategies, which can be significant if you are trying to execute a large proportion of the average daily value of a stock,” noted Adrian Fitzpatrick, head of investment dealing at Aegon Asset Management. “Brussels seem to distrust the sell-side, but we need the services they provide, such as broker crossing networks, to transact our business in a way that limits market impact.”