ICAP enters dark pool market despite volume, regulatory concerns

ICAP, a UK-listed interdealer broker, has revealed plans to launch a block crossing service in 2009, despite the falling volumes and the regulatory uncertainty surrounding non-displayed liquidity venues in Europe.
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ICAP, a UK-listed interdealer broker, has revealed plans to launch a block crossing service in 2009, despite the falling volumes and the regulatory uncertainty surrounding non-displayed liquidity venues in Europe.

ICAP’s Blockcrossing will be open to both buy- and sell-side participants and headed by Daemon Bear, currently head of equity trading at J.P. Morgan Asset Management, who will join ICAP in January. Bear will report to Gary Smith and Peter O’Toole, managing directors of ICAP Securities.

However, continuing volatile market conditions, coupled with a perceived lack of clarity from the UK’s financial regulatory body, the Financial Services Authority (FSA), have caused some anxiety over the use of dark pools, prompting suggestions that the business climate may not be ideal.

Although financial market volatility has dropped off slightly since October, the Chicago Board Options Exchange volatility index is still in the 60-70 points range, corresponding to a high level of market uncertainty.

Figures from J.P. Morgan’s weekly fragmentation index show that non-broker owned crossing networks such as Liquidnet, and the dark trading function of multilateral trading facility (MTF) Turquoise, have seen limited volumes in recent weeks. According to the index, trading on Turquoise’s dark book has been negligible, while Liquidnet, a buy-side only crossing network, traded an average of $28.9 million in November, down from $60 million a week during the end of June and start of August. Figures for Liquidnet do not include trades reported to the London Stock Exchange or trades in stocks listed in South Africa or on certain eastern European exchanges.

Eli Lederman, Turquoise CEO, said his platform had been executing between €5 million and €60 million of dark orders a day, with the overwhelming majority being dark orders interacting with the displayed order book.

“November and December have been disappointing, but 2008 has been another year of growth for our European business overall,” said John Barker, managing director of Liquidnet Europe.

Mark Buchanan, global head of trading analytics at J.P. Morgan, considers the current environment to have played a major part in weakening volumes. “In times of extreme intra-day volatility the opportunity cost of sourcing liquidity from dark pools can be high. MiFID’s imposition of minimum order size requirements has also contributed to low fill rates so far,” he told theTRADEnews.com.

MiFID’s ‘large in size’ stipulations allow crossing networks that use displayed venues for price reference to waive the requirement to publish pre-trade data, thus preserving the anonymity of such venues. Those that do not base their dark pool prices on the primary markets, such as Turquoise, are currently required to have minimum order sizes for their pools, based on the average daily volume and market capitalisation of stock, as defined by the Committee of European Securities Regulators (CESR).

NYFIX Euro Millennium, a non-displayed liquidity pool operated by US technology vendor and agency broker NYFIX, seems to have bucked the trend of falling volumes, reporting a record day on 2 December, with €35.7 billion of available liquidity in the pool. However, Buchanan also notes that some traders may have only been pinging dark pools, as opposed to leaving orders resting there.

Adrian Farnham, COO, Turquoise, has admitted that dark-to-dark crossing on Turquoise has thus far been limited. “We are seeing growing activity in the dark pool from a low base, but the activity so far has been dark trades crossing with visible trades,” he said.

According to J.P. Morgan’s Buchanan, the future looks bright for dark pool operators that are well established in the lit sector and already have a base of liquidity. Turquoise could be considered to have an advantage over other ‘independent’ dark pools because of guarantees from its broker shareholders to provide liquidity during the first six months of its operation. “The general impression is that there will be some consolidation going forward,” said Buchanan. “But the established MTFs that have made good inroads with their lit books are more likely to have more success on their off-order book business.”

Furthermore, the FSA continues to be ambiguous on its stance towards dark pools, which could leave buy-side firms apprehensive over using them. On 27 November, a spokesperson from the UK regulator told theTRADEnews.com that it would not stand in the way of a dark order type proposed by the London Stock Exchange, although similar functionality from MTF Chi-X was halted by the FSA. A story in the FT on 10 November also claimed the FSA were launching a “probe” into dark pools including NYFIX Euro Millennium and Liquidnet.

“It is not clear what the FSA is probing at this point,” said Chris Smith, director at NYFIX International. “However, we believe that the issue centres on the integrity of price formation. We also understand that the FSA in conjunction with other European regulators and CESR are conducting a full review of the intended and unintended consequences of the MiFID regulation.”

Some observers have noted that price formation could be inaccurate if large blocks are executed anonymously, away from displayed venues. However, Smith asserts that because Euro Millennium only executes trades at or within the best bid and offer of the primary exchange and reports all trades instantly, it offers transparent crossing.

Liquidnet’s Barker agrees with the argument that displayed MTFs that offer integrated dark functionality have more to worry about. Experts have observed that MTFs with a public limit order book and an integrated dark feature may be under more pressure as this kind of function will have more of an effect on price formation. Commenting on Liquidnet’s own situation, Barker confirmed, “We are in open dialogue around pre- and post-trade transparency, but it’s not a probe.”