News | Regulation & compliance
Plans for cap on dark pool trading advance
Moves by European regulators to curb off-exchange trading in dark pools have advanced a stage further following the recent agreement by European Union member states to include a cap on dark pool trading in the MiFID II proposals. Fair, transparent pricing
and fair access to markets are regulators’ twin main concerns about dark pools. Set up originally to give institutional investors the anonymity to trade large blocks of shares without causing large movements in share prices, there is a growing feeling that dark pools are no longer achieving what they set out to do. With the advent of algorithmic trading, the average order size in dark pools has reduced while the number of dark pools, operated by brokers, exchanges and independent providers, has grown, driving order sizes down further. The criticism is that the growth and fragmentation of dark pools is making it increasingly difficult for buyers and sellers to find each other and trade at the best possible prices. In its final version of MiFID,
the Council of the European Union has agreed to include two caps on dark pool trading: the first is a 4% limit on the amount of trading per stock per venue calculated over a 12 month
6 Seth Merrin, CEO, Liquidnet
period; the second is an 8% cap on the amount of trading per stock across Europe. The Council’s decision to
back a dark pool cap is an unwelcome development for the industry’s major players, including market leader, Liquidnet. It has argued that regulators should make a distinction between dark pools used by broker-dealers to match orders internally on banks’ trading desks but offer no added value to investors and those, like Liquidnet, that provide institutions with the anonymity, price improvement and facility for large-scale executions that they cannot find on lit exchanges. “If there are lots of dark pools
that don’t provide value above and beyond what the exchanges offer, put that volume back on exchanges,” says Seth Merrin, chief executive of Liquidnet. “But you need different tools
for someone trading £1 million of stock than for someone trading £1,000.” Opponents of the cap also
argue EC regulators could curb dark pool trading using a simpler approach. In Canada, for example, new rules that took effect last October, set a minimum size for dark orders that do not give a significantly better price than public exchanges with the effect that the market share of dark pools dropped by half within two months. In Australia, regulators
have adopted an even simpler approach, allowing any trade to be executed in a dark pool as long as execution comes at a bid or offer price that is better than that offered on lit exchanges. Since May, dark pool trading has declined significantly, the Australian regulator, ASIC, recently announced. n
Best Execution | Summer 2013
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