FiNETIK – Asia and Latin America – Market News Network

This week, Liquidnet, a US operator of “dark pools”, unveiled the latest device to emerge in European share trading, which it called “Supernatural”.

The company claims it will help European fund managers increase their chances of finding matches for large blocks of shares in Liquidnet’s dark pool by linking it up with other exchanges, brokers and alternative trading platforms such as Chi-X Europe.

Yet even as dark pools continue to generate eye-catching ideas, controversy is raging over their very existence. In Europe, the issue is pitting exchanges against big banks in a new battle over control of billions of dollars in share trading orders.

Dark pools allow the matching of large blocks of shares without prices being revealed until after trades are completed. Regulators on both sides of the Atlantic are studying them amid questions over their transparency.

Dark pools are not only run by companies such as Liquidnet; they are also operated by banks’ trading arms and exchanges. They have grown rapidly since first appearing in the US in the late 1990s, with at least 15 in existence in Europe.

The exchanges have launched an attack on the proliferation in Europe of pools run by the banks – such as Goldman Sachs, Credit Suiss, and Morgan Stanly – arguing they are operating outside the view of European regulators. 

Mifid launched competition in European share trading in 2007, leading to an explosion of new type of trading venues.

The Federation of European Securities Exchanges, whose members include Deutsche Börse  and Euronext , wrote this week to the Committee of European Securities Regulators in Paris, claiming banks’ dark pools were “unregulated venues” operating with “full opacity”.

It said that under Mifid, crossing networks were supposed to register under certain formal categories that would subject them to the same market surveillance and price reporting requirements as exchanges.

Yet many were not, FESE claims. “Practically all of this trading is outside the realm of European rules and thus beyond the reach of supervisors,” wrote Judith Hardt, FESE secretary general, in the letter to CESR chairman Eddy Wymeersch, a copy of which was obtained by the Financial Times. “As a result, more trades are being executed away from the public view, without interacting with other orders, and at prices that may not be optimal for clients.”

She argued that European equity markets “are becoming a dealer market”.

The banks are furious. They see the FESE move as exchanges exploiting post-crisis concerns over off-exchange markets to persuade policymakers of the benefits of channelling trading of stocks through regulated exchanges.

Dark pool trading accounts for about 4 per cent of all trading in Europe, according to consultancy Tabb Group. But it is growing, and with the proliferation of the types of “dark” trading venue unleashed by Mifid, bankers say exchanges fear trading could shift further away from them. “The exchanges are opportunistic, fear-mongering. And it’s pretty clear why: commercial interest,” says one.

The banks reject the notion that their crossing networks are unregulated, pointing out that broker-dealers are already regulated, and the banks’ clients – such as money managers – are regulated.

They also argue that their dark pools perform a legitimate function at a time when large orders are increasingly hard to execute on exchanges as complex electronic trading strategies slice orders into smaller and smaller sizes.

They reject the FESE view that investors are at a disadvantage by the alleged “opacity” of bank dark pools. They say that many of the block trades being carried out in them are placed by the banks’ asset manager clients, which in turn are handling funds placed with them by millions of ordinary investors.

The problem, industry experts say, lies with Mifid itself. Exchanges say that bank dark pools are not required to report trades in a coherent way, or even at the same time as those trades reported to the market by exchanges. Mifid is unclear on the issue.

Steve Grob, director of strategy at Fidessa, a trading technology company, says: “The reporting environment in the US is much more transparent. There needs to be some clear regulation about how they report what they do.”

Niki Beattie, managing director of The Market Structure Practice, a consultancy, says: “The thing is that brokers are governed by a certain set of rules and exchanges are governed by another. Mifid failed to move with the times.”

She believes, however, that Mifid has given brokers an “unfair advantage” over exchanges. “They are both trying to be liquidity pools and [Mifid] has given the brokers an unfair advantage,” says Ms Beattie, a former trading strategist at Merrill Lynch.

CESR is studying the issue. Last week Charlie McCreevy, European Union internal markets commissioner, said dark pools would form part of the European Commission’s planned review of Mifid. That would focus on whether the growth of those operated by broker-dealers gives their backers “unfair commercial advantages” in the market.

With dark pools under attack more broadly, banks may have a tough job making their case. Ms Beattie says: “The exchanges probably have some right to be out there questioning this.”

Source: FT, 24.09.2009 by Jermy Grant

Filed under: Exchanges, News, Risk Management, Trading Technology, ATS Alternative Trading Systems, CESR Committe of European Securities Regulators, Chi-X, Compliance, Credit Suisse, Dark Pools, Europe, FESE Federation of European Securities Exchanges, Goldman Sachs, Liquidnet, Mifid, Morgan Stanley, Regulation