Limits on European dark pools will not work in their current form, according to the parliamentarian with a key role in implementing them. A survey from London Stock Exchange Group Plc suggests he’s right.
Dark-pool trading could become impossible for almost all of the U.K.’s 100 largest listed companies -- the constituents of the FTSE 100 Index -- when the European Union rules take effect in 2017, according to LSE’s research. About half of the FTSE 250 Index, which measures the next biggest 250 firms, would also fall foul of the caps, the study showed. LSE looked at trades that took place on dark pools and privately negotiated deals during 2014.
“My personal conviction is that the double volume cap will not function,” Markus Ferber, the member of the European Parliament leading work on the overhaul of European Union markets regulation called MiFID II, said at a conference in Paris. “Now it’s my obligation to make them functionable.”
Some investors use dark pools to trade large blocks of shares without giving others the chance to bet against their trades. Dark venues don’t disclose order prices until after the transactions are executed. If investors sought to trade such large blocks on a public exchange, other market participants would immediately see what they were doing.
The EU-wide rule change, which comes into force at the start of 2017, limits the amount of trading in a single stock that can take place on a single dark venue at 4 percent, and the amount that can be traded overall in dark pools at 8 percent.
Dark-pool trading is currently allowed under what’s known as the reference-price waiver, while banks can process over-the-counter trades away from the glare of public markets under an exception called the negotiated-trade waiver. The MiFID II changes will limit both types of transactions. Those restrictions don’t apply to big -- or large-in-scale -- trades.
From 2017, investors will be prevented from trading a stock on any dark venue for six months if activity exceeds the 8 percent cap on overall dark trading.
“It would appear that the double caps and the ideas and concepts around that were conceived without having sufficient data to understand how these might interact and might impact trading,” said Brian Schwieger, head of equities at LSE. “What the study really underlines is the fact that it’s not just the dark trading that’s being affected here. It’s also the OTC trading, and that’s an important part of that.”
In The Dark
The banks could help more stocks remain available for dark trading by changing how they report their OTC transactions. Almost 80 percent of negotiated-trade reports in the LSE study could have been flagged as large-in-scale, Schwieger said. That would have removed them from the scope of the trading caps. LSE reached its conclusions by examining how much dark trading took place using the negotiated-trade and reference-price waivers.
“As of yesterday we started engaging with the Financial Conduct Authority on that point and sharing some of our findings with them,” he said on Wednesday.
Part of the problem with the proposed caps is the lack of available data, Ferber said. As the member of parliament overseeing the implementation of MiFID, Ferber could help change the rules if they are shown to damage markets.
“We have a lack of data to really understand what is happening in the dark,” Ferber said. “I’m the first one who is ready to change the system.”
A second package of regulations -- called Emir -- will provide policy makers with the data on OTC trades needed to help them understand the dark-trading caps, but those regulations have been delayed. The data will now become available in 2016, Ferber said.
In the meantime, market operators are preparing for the incoming regulations. LSE’s Turquoise venue has created its Block Discovery service for trading large orders, and Investment Technology Group Inc. has revamped its algorithm for finding the best available stock prices.