Dark pool operators must inspire long-term loyalty through differentiated service, or risk being eclipsed by new, innovative platforms, recent shifts in the market share of Europe’s dark multilateral trading facilities (MTFs) suggest.
From Q1 2011 to Q1 2012, established dark venues including Liquidnet, NYSE Euronext’s SmartPool and Nomura’s NX dark pool have lost market share, while newer platforms such as UBS MTF and Goldman Sachs’ SIGMA X MTF have seen significant growth.
In March 2012, Chi-X Europe's Chi-Delta increased its market share from 23% to 25%, while agency broker ITG's POSIT dark pool ticked up from 13% to 14%. UBS MTF kept its market share steady at 14.5%, but Goldman Sachs' SIGMA X MTF rose slightly from 11.45% to 11.74%. The biggest monthly losers were BATS Europe, which fell two percentage points month-on-month to end March on 9%, and Turquoise, which slipped from 9% to 7%. Over the same period, SmartPool decreased from 2.51% to 1.85%, Nomura NX 4.93% to 4.65%, while Liquidnet fell from 5.85% to 5.59%, but all three have experienced larger reductions over the last 12 months.
Innovative offerings
Part of the explanation for swings in market share could be the continuous introduction of functionality on newer platforms that broadens the price points at which trades can be completed.
SmartPool saw its market share slide from 8.4% in March 2011 to just 1.85% in March 2012. Meanwhile, Nomura NX fell from 8.1% a year ago to 4.65% market share in March this year.
“The ability to trade at the bid and the offer, rather than just at the mid point, has been quite a dramatic change,” said Andrew Bowley, head of electronic trading product management at Nomura. “Without a doubt some of the venues that have jumped up the league tables have had a very high proportion of bid and offer trading, and that’s a significant part of the trend occurring in the marketplace.”
Both UBS MTF and SIGMA X MTF offer trading at the bid and offer. Both platforms have also attracted high-frequency market markers to increase flow. Nomura is in the process of rolling out its own bid and ask order books for NX. Bowley said the new price points have increased trading volumes on rival platforms that offer the functionality at a rate of about 5% a week.
“It’s really important to keep the distinction between bid and ask trading and our mid-point book,” he said. “We haven’t changed the mid book – we’ve simply introduced something new and separate. Nomura’s high-speed bid and offer matching books are designed for market making flow, while the mid-point matching engine runs periodic auctions with anti-gaming controls and remains for block trading. It’s all about client choice.”
Nomura also operates VWAP crossing – giving users a total of four possible ways of interacting with dark liquidity.
Size or speed?
Europe’s dark MTFs achieved their highest recorded volumes in March, reaching €30.46 billion in March, versus €28 billion in February and €24 billion a year ago. However, total European dark trading – including broker crossing networks (BCNs) – actually fell slightly as a proportion of Europe’s total order book, from February's record of 7.65% to 7.24%. BCNs traded a total of €30.63 billion last month, according to figures from Markit as reported to Thomson Reuters. Total trading across lit and dark European equity trading venues reached €787 billion in March, up from €740 billion in February.
Advances in functionality are not the only deciding factor in changes in trading preferences between venues. According to John Barker, head of international, and Per Loven, head of international corporate strategy at Liquidnet, the rise and fall of block-focused dark pools’ market share over the last year reflects market volatility, the rise of high-frequency trading (HFT) activity, and the withdrawal of the institutional investors during the second half of last year and the beginning of 2012.
Liquidnet saw its trading volumes fall from €2.46 billion in January 2011 to €1.61 billion 12 months later. The buy-side focused block crossing network traded €1.64 billion in March 2012.
"In the second half of last year, we increasingly saw a decrease in execution size, institutions spreading trades out over a longer period, due to the volatility and uncertainty in the market,” said Loven. “However, this year we are seeing a decrease in volatility and the return of block trading."
Loven estimates that HFT as a percentage of European trading has increased from 35% to 45% over the last 12 months, while institutional non-HFT flow – Liquidnet’s core market – has decreased by around 30% over the same period. “Compared to market context, we’re actually tracking our best ever quarter,” he said. Liquidnet estimates that of some €2.7 trillion traded in European equities in Q1 2011, around €1 trillion represented HFT activity – leaving around €1.7 trillion institutional and retail flow. By contrast in Q1 2012, only €2.2 trillion was traded, of which around €1.1 trillion consisted of HFT flow.
“That’s a 33% fall in the area of the market we can pursue, and that squares exactly with our Q1 results year-on-year,” said Barker. “We are tracking what is available to us, so we are confident that we are following the institutional market volumes.”
Discretion versus regulation
Other market participants suggest that the rise and fall of different platforms may be influenced by cyclical factors and potential regulatory changes under MiFID II. Since dark MTFs are non-discretionary, they cannot prohibit access. This can lead to a natural progression of high-quality market participants from one venue to the next, according to Mark Goodman, head of quantitative electronic services at Société Générale Corporate and Investment Banking.
"The fact that dark MTFs are non-discretionary may help explain the pattern that we often see in dark pools, whereby they start, pick up flow, expand as they become more popular and then drift back to lower market share again,” he said. “As they become more popular, the quality of participants goes down – but there’s no way for these venues to choose the participants. As clients see toxicity rise they reduce their flow to that pool and begin to use others, and so the cycle repeats itself."
The inability of MTF operators to select flow may be exacerbated by the possible impending demise of BCNs, which do allow operators more flexibility on access and matching logic. Goodman points out that the proposed MiFID II requirement for BCN operators to run either an MTF or a systematic internaliser may well result in venue consolidation.
"I expect we’ll see fewer dark trading venues in future, because some of the independents don’t have enough flow to survive,” he said. “Venues need to differentiate themselves – it’s in nobody’s interests to have multiple venues that are essentially the same as each other."
According to Liquidnet’s Barker, market trends support further growth in block trading again after a period in which selling has outstripped buying interest by a significant margin.
"Across all of 2011, we saw predominantly net selling over buying – at its worst point, up to 70% selling, 30% buying,” said Barker. “But during Q1 this year, we have seen a shift to net buying over selling, from a sentiment standpoint this is really important. We are seeing good signs that institutions have more liquidity, they are starting to be net buyers, and as the volatility in the market comes back to more stable levels, they will trade more."