The fragmentation of liquidity in Europe since the introduction of MiFID has had no material impact on the quality of the price formation process, but dark pools can cause problems with price discovery, according to new research by the CFA Institute Centre for Financial Market Integrity.
The study, which includes empirical analysis and a survey of 962 CFA Institute members involved in investing, trading, or processing orders in European equity markets, found no empirical evidence to suggest that fragmentation was damaging price formation. However, 71% of the survey respondents that expressed an opinion thought dark pools were either somewhat (45%) or very (26%) problematic for price discovery.
In addition, 58% believe dark pools cause difficulty with market liquidity, and 69% with market volatility.
“Anything that masks the available liquidity at various price points from market participants is prima facie bad for markets and for investors at large,” said one respondent.
Another added, “By not being able to adequately gauge the depth of the market, through public information on volumes and prices, investors can interpret market movements incorrectly.”
Nevertheless, the report noted that the absence of pre-trade transparency in dark pools allows investors to execute large blocks of stock without showing their hand, minimising market impact costs.
Some respondents clearly feel dark pools are little cause for concern. “In Europe, and I would have thought in the US too, there is little difference between there being liquidity in dark pools or liquidity in ‘iceberg’ orders in the market or a block ‘upstairs’ being worked by a sales trader. These dark pool venues can often provide improvement in price/liquidity.”
Although the empirical study discovered little evidence of fragmentation harming price formation, survey respondents were concerned about its impact on post-trade data. Sixty-eight percent reported difficulties in fulfilling post-trade reporting obligations, while 64% indicated that fragmentation had increased the cost of data access.
Accordingly, 65% of survey respondents support the implementation of a mandated consolidated tape for European equity markets.
Only 27% of respondents felt MiFID had been successful at increasing competition and levelling the playing field in European equities, compared with 41% who felt it was unsuccessful and 32% who had no opinion.
“Exchange competition has increased, but the playing field in equities resembles a cratered lunar surface,” said one respondent.