As the Securities Exchange Commission in the US puts pressure on measuring and defining dark pool activity, the same debate is occurring in Europe where buy-side equity traders are having a love-hate relationship with the dark.
Trading in dark environments is estimated by Tabb Group, the capital markets research and consulting firm, at 4.1 per cent of daily turnover in major European markets, forecast to increase seven per cent in 2010 as buy side traders acquire the knowledge, tools and insight to increase their confidence to trade where they cannot see.
Although the infrastructure for trading in a multi-layered, pan-European marketplace is largely in place, the buy side is still adopting and upgrading tools, the sell side is expanding the intelligence of algorithms and traders tell Tabb that they need time to adjust.
Across the market, algorithms are becoming better at preventing information leakage, and spotting crossing opportunities and liquidity aggregators is gaining in sophistication. Data is available to those who know what they want, when they want it and have the means to process it when they receive it.
Still, in a European marketplace very much in flux, the buy side is picking through a plethora of algorithms, leading Tabb to pinpoint eight questions buy-side traders should ask about their broker’s dark strategy to determine what, where, when and how their order is being traded.
Miranda Mizen, a principal at Tabb, says the pending regulatory review in Europe should add clarity, review the Mifid waivers and remove the ambiguity around dark environments, thereby anchoring dark trading as a legitimate alternative that complements the lit markets.
“Regulation may restrict unfettered expansion of dark environments by raising the bar on competition, but it will also marginalise those with paltry liquidity.”
Current reporting standards, the spectre of a regulatory review and lack of volume in some have created uncertainty about how much volume is traded in the dark, and a reluctance to share.
Tabb Group estimates there are 33 dark environments operated by a combination of brokers, lit multi-lateral trading facilities and exchanges but the large choice “does not de facto add to the quality of the dark environment,” says Mizen.
Unless regulation becomes a barrier, Tabb Group believes the number of dark environments will continue to increase but “as liquidity splinters, this will work against the buy side as liquidity becomes harder to find without leaking information,” and this increases the need for smarter aggregation.