Dark Pools and Platonic Love

Lenders' plans to create their own non-profit trading venue look hopeful.
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In the wake of "Flash Boys," regulators are clamping down on dark pools, threatening their profitability. The latest response from banks sounds improbable: they're teaming up to create a non-profit trading venue for stocks.

Rising Share

Dark pools' share of European equity trading has climbed to a record this year

Source: Bloomberg News/Rosenblatt Securities

A dozen lenders and asset managers, from Goldman Sachs to Fidelity, are opening a trading association in Europe called "Plato" -- the patron philosopher of trading terms like "fill or kill" -- focused on cutting trading costs and "championing" investors. On Tuesday, the group announced a partnership with the London Stock Exchange's Turquoise platform.

As bizarre as it sounds, it makes sense when viewed as a defensive move. The latest round of Mifid rules in Europe are going to make it more expensive for banks to run a dark pool and will require greater disclosures about them. European regulators are actively considering caps on how much trading can be done in the dark.

Given that pressure, it makes sense to reduce costs by pooling ideas, standards and data. The deal with the LSE will also give the firms a venue where they can try out new ideas and technology, while spreading the risk and limiting the outlay.

Dark Arts

Banks hold significant market share of U.S. dark-pool trading

Source: FINRA ATS Transparency Data, NMS Tier 1, Q2 2016

The problem will be where cooperation ends and competition begins. Banks are likely to still want to devote most of their resources to retaining a competitive edge, whether commercial or technological -- and that means making sure most of the secret sauce stays secret. Asset managers, too, are unlikely to suddenly want to open up their order books to each other or to their banks -- even if they're being promised more reliable data. Funding academic papers or research on how to better trade small-cap stocks might be nice and neutral territory but it's unlikely to be a game-changer on its own.

It's hard to see how Plato offers an immediate help for the the banks. There's no immediate revenue gain. Prioritizing their own platform or guaranteeing order flow would flout best execution rules; playing favorites with fees or searching for cut-price deals would flout competition rules.

The banks' best hope may be to use research from the group to help them reduce costs and find new ways to be competitive -- in their own corner.

So the plan looks likely to remain a Platonic ideal. In practice, we're a long way from getting closer to seeing how regulator-approved dark pools run by banks will look. Plato itself has taken years to get off the ground -- first reported in December 2014, it last issued a statement on its progress in July 2015, as Bloomberg News's John Detrixhe has pointed out -- and it's not hard to see why. Natural rivals are unlikely to stay friends for long.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

    To contact the author of this story:
    Lionel Laurent in London at llaurent2@bloomberg.net

    To contact the editor responsible for this story:
    Edward Evans at eevans3@bloomberg.net

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