Europe’s broker-owned dark pools or crossing engines will be more open to toxic flow and less able to provide price improvement if they are forced to register as multilateral trading facilities (MTFs), brokers claim.
Currently, brokers can operate dark pools in Europe without registering them as one of the three MiFID-defined types of trading venue: multilateral trading facility; systematic internaliser; or recognised investment exchange.
Some brokers have registered their crossing engines as systemic internalisers, but indications that regulators could require reclassification have intensified in recent weeks. In a speech on 18 September, Charlie McCreevy, European Commissioner for internal market and services, said that the Commission’s review of MiFID’s impact on equity trading in Europe, due to start at the end of this year, would address whether dark pool operators were afforded unfair commercial advantages.
This week, Eddy Wymeersch, chairman of the Committee of European Securities Regulators (CESR), the body responsible for harmonising regulation across Europe’s securities markets, said broker dark pools “should organise themselves as MTFs, or something similar”.
“Technically, there could be some challenges for broker pools if, for instance, the current architecture only allows access to the pool via a ‘single member’ – i.e. the broker itself,” said Steven Brown, director of regulation and compliance at trading technology firm RedKite Financial Markets and a former member of the team that drafted the UK Financial Services Authority’s MTF authorisation procedures. “An MTF has to be multilateral to ensure that its owner has no advantage over other members using the venue in terms of information, latency and so on.”
But wider access to a broker’s dark pool could expose its buy-side clients to potentially harmful orders. “It would damage our ability to facilitate client flow,” one broker said. “We would not be able to exercise any discretion about who has access provided they meet certain criteria, so we could let in stat-arb traders, electronic market-makers, external liquidity providers etc. Our institutional clients would not want that. I hope regulators will see that this is potentially damaging to institutional flow.”
A further concern expressed by brokers is that a shift to MTF status would restrict the types of trading activity possible in their dark pools, thereby reducing their appeal to clients. MTFs can only offer dark trading by complying with one of four pre-trade transparency waivers. So far, many MTFs have opted for the reference price waiver, which only permits orders to be crossed at the mid-point of the best bid and offer of a reliable source, typically the primary exchange for the stock being traded. Broker-owned pools that follow this route would have severely limited scope to offer price improvement.
MTFs can offer non-mid-point dark trading by using MiFID’s large-in-scale waiver, but such trades cannot interact with any mid-point trading and must be executed on a separate order book.
Some market observers argue that a system that requires agency brokers such as Liquidnet and ITG to operate their crossing platforms as MTFs, but allows investment banks to run unclassified pools, is untenable and regulatory action is inevitable.
However, it is still unclear whether regulators will force brokers to seek MTF status. Despite Wymeersch’s comments, a spokesperson for CESR told theTRADEnews.com that the committee has no official position on classification of broker pools beyond comments made in its summary of market participant feedback on the impact of MiFID on secondary markets, published in June. In the report, the Committee acknowledged complaints from exchanges and MTFs about brokers unclassified crossing operations, but said the matter required further consideration.
“Work to develop a CESR position is in the very earliest stages and I cannot indicate precisely the timing of when this will work will be completed at the moment, as CESR is still in the process of finalising the work programme for 2010,” the spokesperson said.