Liquidnet Europe, a non-displayed buy-side-only crossing network, has had to change the basis under which it protects client orders from pre-trade transparency, following intervention by the Financial Services Authority, the UK financial regulator.
Previously, Liquidnet Europe operated under a negotiated price waiver, as outlined in the Markets in Financial Instruments Directive, but has been required by the FSA to
adopt a combination of two of MiFID’s other pre-trade transparency waivers.
Liquidnet will now use the large-in-scale waiver for larger transactions, for which buy-side users will still be able to negotiate prices bilaterally. For orders that fall below MiFID’s large-in-scale requirements, Liquidnet will employ the reference price waiver, which stipulates that orders must match at the mid-point of a reliable reference best bid and offer to avoid pre-trade transparency. The firm expects to go live with the new waivers by the end of January 2010.
The change follows almost a year of talks with the FSA, which regulates Liquidnet Europe as a multilateral trading facility. The regulator has determined that venues without an order book cannot employ the negotiated price waiver to exempt them from MiFID’s pre-trade transparency requirements.
The Liquidnet system polls the order and execution management systems of participating buy-side firms allows the buyer and seller to negotiate the price for the trade once a match is found.
The ability to use a combination of the large-in-scale and reference price waivers means Liquidnet will not lose any business as a result of the change, according to John Barker, head of Liquidnet Europe.
“Had the FSA forced us to go large-in-scale only, we would have probably lost about 15% of our executions but probably only about 5% of our revenue, because we would have lost the smaller transactions,” Barker told theTRADEnews.com.
The main difference will be felt by users submitting orders below the large-in-scale threshold, as they will no longer be able to negotiate prices for these orders.
Under the new system, Liquidnet will compare the size of buy and sell orders from members’ order and execution management systems once a match is found. If the order size for both sides of the transaction is above the minimum level required under MiFID, the trade will be subject to the large-in-scale requirements for the remainder of the trading day. If one or both sides fall below the minimum level, the trade will be subject to the reference price waiver.
Because large-in-scale and mid-point orders cannot interact under the FSA’s rules, Liquidnet will need to prove it has the functionality to separate out the two types of orders.
“The changes aren’t big and most won’t notice a difference,” said Barker. “We capture the data, apply the MiFID tables on a stock-by-stock basis to determine what is large in scale, and make the calculation prior to the match.”
MiFID defines large-in-scale orders with reference to a stock’s average daily turnover (ADT). For example, an order in a stock with an ADT of less than €500,000 would need to be €50,000 or bigger to be considered large in scale. The ADT data for stocks used in MiFID’s waivers is collated and published by the Committee of European Securities Regulators, the body charged by the European Commission with ensuring consistent implementation of securities regulation across Europe.
Liquidnet is not the first European dark pool to have to change its operating structure at the behest of the FSA. From 14 April this year, fellow non-displayed platform NYFIX Euro Millennium has only matched orders at the mid-point of a reference price instead of at or within the best bid and offer, following a request from the FSA.
Despite the FSA’s change of tack over the Liquidnet’s pre-trade waivers, Barker described the experience as positive.
“The FSA has given us ample time to put our case together, as they recognised the value of our service,” he said. “So while it has taken close to a year to get to where we are, it has been an active two-way dialogue. What was more important to us than losing a waiver was the FSA being fair and giving us time to work out the best possible long-term solution. Our biggest fear was being asked to use a waiver that didn’t match our business model. Most of our business is large-in-scale, so the majority of our executions being subject to this waiver is logical.”