Proposals by the European Commission (EC) to curb trading activity in broker crossing networks (BCNs) could put the future of such platforms in jeopardy.
The warning comes from Damian Carolan, regulatory partner at law practice Allen and Overy, who claims that various proposals to reclassify BCNs in the EC's MiFID consultation, do not seem to fully appreciate their benefits. The consultation period ended on 2 February, with regulatory proposals for MiFID II expected in Q2 this year.
“Regulators now seem to be taking the approach of squeezing those elements of the market they don't like the look of,” Carolan told theTRADEnews.com. “By imposing additional regulation and forcing BCNs to turn into MTFs, regulators can potentially make running a BCN impractical for sell-side firms.”
Carolan adds that the possibility of increased transparency requirements for BCNs is also in danger of going too far. Under MiFID II, all BCNs face the possibility of having to identify their trades in post-trade data and make aggregated information on daily trading activity public at the end of each day.
“There is a move towards greater transparency across the whole market, and in the case of BCNs, it is important that the market knows trades have been executed in a certain type of venue,” said Carolan. “Some form of aggregated post-trade transparency is a good thing for BCNs, but if this is too aggressive, and combined with the trigger events for reclassification, the viability of BCNs will be compromised.”
In its MiFID consultation paper, the EC suggested that under particular circumstances BCNs would have to change their regulatory classification.
BCNs would initially be classed as a subset of the organised trading facility regime, a catch-all category covering a range of different trading platforms. But if they traded over a certain amount, or allowed third-party access to their platforms, the EC suggests BCNs could be reclassified as MTFs. If a BCN is required to turn into an MTF, it would no longer have discretion over how it handles orders or which participants can trade on the system, and be required to display quotes unless it uses one of MiFID's pre-trade transparency waivers.
Rules around third-party access could mean various links between BCNs and MTFs have to be revisited or terminated. Currently, links exist between agency broker Instinet's Blockmatch MTF and Credit Suisse's Crossfinder BCN; and the BCNs operated by UBS (UBS PIN), Goldman Sachs (SIGMA) and Morgan Stanley (MS Pool).
Crossfinder is accessible via Instinet's smart order router, while Goldman Sachs, Morgan Stanley and UBS are each an algorithmic client of the other two brokers under their link so, for example, Goldman Sachs can only use UBS algorithms to gain access to UBS PIN.
The proposal may also pose a risk to TQ Lens, the aggregation service offered by Turquoise, the London Stock Exchange-owned MTF. TQ Lens has links with seven broker partners comprising: CA Cheuvreux; Citadel Securities; Citi; Deutsche Bank; Bank of America Merrill Lynch; Nomura and Instinet.
Sören Steinert, associate director, equities trading at Germany-based Quoniam Asset Management, which trades around 35-40% of its equity orders in the dark, notes that links between BCNs can be a big factor when deciding where to send certain orders.
“Unlike some MTFs, BCNs do not include high-frequency or predatory trading flow,” he said. “Therefore, when I have a large institutional sized order, the potential liquidity I have from the link between UBS, Morgan Stanley and Goldman Sachs, for example, is significant and valuable compared to the liquidity in dark MTFs.”
Observing that the technological requirements for reclassification of BCNs will be easier to meet than regulatory burdens, Ian Salmon, head of enterprise business development, Fidessa, thinks adoption of the EC proposals could lead to greater fragmentation of dark pools among brokers.
“It's likely firms could end up with a portfolio of different crossing services, each with a different profile of flow going through them,” said Salmon. “Firms have already tried to position themselves to show they can be proactive to new regulation and take advantage of new business opportunities.”
Turquoise, Credit Suisse, Goldman Sachs and UBS all declined to comment on the future of their links with other dark pools, while Morgan Stanley did not return calls.