Operators of dark pools in Europe are predicted to spend €20.09 million on anti-gaming and surveillance logic by 2012, rising from €17.11 million this year, to alleviate buy-side fears about negative selection and gaming.
The forecast is made by consultancy TABB Group in a new report, ‘Decisions in the dark: aligning results with expectations in European equities’, which examines the changes in the dark trading environment in Europe and considers what traders should be looking out for when using non-displayed trading venues.
One of the biggest concerns for buy-side firms, according to TABB principal and author of the report Miranda Mizen, is protection from toxic order flow.
“Toxicity is situational,” she says. “For one order, fast money is a welcome source of immediate liquidity; for another, it can ruin the day. Although the choice of dark environments can be dazzling for those seeking quality, given the wide variety of order flow that needs to be executed, choice is good, provided it is understood. But the buy-side needs to know the strengths and pitfalls of individual dark strategies, how to choose the most appropriate dark strategy and how best to measure the success of a particular strategy.”
According to Mizen, choosing the most appropriate dark strategies entails evaluating market microstructure factors such as execution quality, costs, trade size and potential for information leakage. As dark trading continues to evolve in Europe, the study observes that buy-side firms will rely even more on sell-side counterparts for the best technology to access the ever-increasing number of dark multilateral trading facilities and broker dark pools.
“The search for execution quality in the dark becomes a duopolistic responsibility between those seeking it and those who provide it,” said Mizen. “In the end, aligning results with expectations, they need to apply an informed, customised approach to each order, essentially a combination of control, knowledge and trust.”
The study also looks at the potential impact of the European Commission’s upcoming review of MiFID on the dark trading environment. Potential reforms include the reclassification of broker dark pools to multilateral trading facilities once they reach a specified size, changes to the pre-trade transparency waivers used by dark pools to remain anonymous and post-trade data consolidation, which will better inform traders of where liquidity is aggregating in a standardised way.
“Regulatory resolution of post-trade transparency will also improve visibility over where dark liquidity is collecting, helping to make the determination of how to find quality in the dark easier for the buy side,” wrote Mizen in the paper’s conclusion.