Dark Pools Must Tame Conflicts of Interest, U.K. Review Says

  • The venues must provide more detail about how they operate
  • MiFID II will restrict European dark pool trading in 2018

The Financial Conduct Authority is pushing dark pool operators to better handle any conflicts of interest, a sign of mounting scrutiny of the electronic trading platforms after brokers faced a series of penalties in the U.S. last year.

Dark pools should also provide precise detail about their operations and improve how they monitor market abuse, the U.K. regulator said in a review on Thursday. Developed to aid trading of bigger blocks of stock, dark pools are so named because they don’t display prices like a public exchange.

Watchdogs have been paying more attention to how dark pools work. U.S. regulators have cracked down on platforms run by Credit Suisse Group AG, Investment Technology Group Inc. and UBS Group AG, putting those firms on the hook for tens of millions of a dollars. Five years ago, dark pools accounted for only 2.7 percent of European trading, according to data from Bats Global Markets Inc., which runs the biggest pan-European stock market. That number had risen to 7.5 percent as of December.

The FCA said it will provide additional feedback to individual dark pools and may require them to fix problems.

“Advances in technology have had a huge impact on equity markets which, in turn, give rise to new forms of conduct risk,” Andrew Bailey, chief executive officer of the FCA, said in a statement. “Similar changes are underway across other products and markets so it is important for boards and senior management to read across, and apply what they have already learned, to rapid changes occurring elsewhere.”

While dark pools have improved internal controls in recent years, the FCA said banks and other firms that operate the platforms still must take additional steps to ensure integrity and fairness. The regulator highlighted the firms’ monitoring and oversight powers, saying that they can lag well behind the speed of modern markets, where transactions can occur in milliseconds.

There’s a “heightened potential” for conflicts of interest when dark pool operators use their own inventory to match client orders, instead of sending the orders to the wider market, the regulator said. The FCA said it was concerned that some banks allow access to dark pools by their own traders “in a manner which may provide an unfair advantage,” while the systems “may not have been policed in a sufficiently robust manner, potentially breaching requirements.”

The FCA briefly addressed the U.K.’s decision to leave the European Union. Much of the U.K.’s financial regulation derives from EU legislation, and it will remain applicable until any changes are made by the British government, the regulator said.

Dark pools are subject to EU laws including MiFID II rules that come into force in 2018. Those regulations will limit off-exchange trading. Bank run dark pools known as broker crossing networks will also be phased out.

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