Under current MiFID regulation, pre-trade transparency waivers are used to allow non-displayed trading venues to forego the need to publish bids and offers prior to execution. With average trade size falling on these venues, often referred to as dark pools, there is a feeling among regulators and indeed exchanges, that these venues are having a negative impact on price discovery and liquidity.
The danger, however, of reneging or capping volumes traded under these waivers and applying potentially broad-based regulation under MiFIR, is that all dark venues will be treated the same. In reality, they differ widely in concept, market model, and the overall value they provide.
“Not all dark pools are created equal. It’s a complex area, with different types of activity, different market participants. Let’s understand what these differences are and not treat all dark venues the same,” stresses Per Lovén (pictured), Head of EMEA Corporate Strategy & Product at Liquidnet.
Liquidnet is a unique institutional block trading venue, where buy-side institutions can trade large orders without having to declare their intentions to public exchanges. A dark pool, says Lovén, should offer value over and above what you find in the lit market: “That value tends to be realised in one of two ways: either you offer price improvements (trade within the spread, ideally at the midpoint), or you offer a way of minimising market impact.”
There are, as stated, many forms of dark pool. Liquidnet sits at one end of the spectrum as a buy-side MTF that supports block trades, and has an average execution size of around EUR900K. Moving across that spectrum you have other agency broker MTFs (e.g. ITG Posit), then the broker-dealer run internalisers – known as Broker Crossing Networks – and finally exchange/sell-side MTFs such as LSE Turquoise. The average execution size across these venues ranges between EUR30K and EUR5K.
Liquidnet’s members are typically global pension fund and mutual fund managers. According to data provided by Liquidmetrix, they save an average of 100 basis points by executing these blocks in the dark.
Were Liquidnet to be forced under regulation to provide greater pre-trade transparency, these institutions would be adversely affected by market impact. “That’s the fundamental point. Venues like Liquidnet were created because institutions were growing so big that their trading impact on the market was becoming more prevalent. If you take away such an outlet for them to trade blocks anonymously you’re going to directly lower the return and size of assets that retail investors have in their pension funds. It’s the regular guy on the street that would feel the impact of such regulation,” says Lovén.
“Policymakers and regulators are understandably concerned about the amount of trading that takes place in off-exchange trading venues that do not provide value over and beyond what the exchanges can provide. We believe that it is wrong to restrict the activity of those off-exchange venues that provide best execution and increased value to investors.
“Our Members pay a commission for trading with us but the implicit price improvement they get by minimising market impact is clearly understood. This sometimes gets lost in the wider dark pool debate.”As Seth Merrin, founder and chief executive of Liquidnet, wrote in the Financial Times on 3 May 2013: “Not all dark pools are the same and any debate on restricting their activity should recognise that some exist precisely for the reason they were formed.”