A ROSE BY ANY OTHER NAME…?

Despite the trading community’s best efforts, the moniker dark pools has stuck. This is probably because “trading without revealing pre-trade price information” is not very catchy. One wonders though if the name was different whether regulators would be so intent on restricting activity.

The answer is probably yes and the arguments would have been the same. The proponents on both sides of the Atlantic argue that clients save money if their brokers do not have to pay exchange fees while institutional investors are going off-piste in order to avoid the market moving against them, or having to trade in small amounts with computer algorithms.

The public venues, on the other hand, feel hard done by because they have to comply with certain more stringent rules than their unlit counterparts. They also believe that the decreasing size of trades executed in dark pools, which can sometimes be only a couple of hundred shares, does not warrant some of the trading exemptions that dark pools receive.

In many ways it seems like a tempest in a teacup because dark pools are still a fraction of the market, but they are making their presence known.  According to a new study by TABB Group, these venues only accounted for 11% of volume, but that is up from 2% three years ago while dark pools at alternative trading venues operated by companies such as BATS Chi-X Europe, Goldman Sachs Sigma X, UBS MTF, Turquoise and Instinet have enjoyed a market share rise to 5% from 3.2% in the last 12 months alone.

This explains why the regulators are moving in. The European Commission wants dark pools to offer price improvement — which would only allow trading in dark pools at prices better than those found on public markets. This is in addition to imposing volume caps on the amount of dark trading that can be done on a single venue and on an EU-wide level. This concept was first introduced in the Council’s draft of MiFID II while the European Parliament favours a pricing improvement rule.

The lines are being drawn in the sand with the exchanges backing the Commission’s latest proposals while the sellside worries that the proposals may limit investor choice which is one of the hallmarks of today’s high-tech and fragmented market structure. Perhaps the best course would be to follow the advice of Rebecca Healey, author of the TABB report,who said, “Regulation would achieve more by ‘cleaning up’ dark trading, clarifying the rules within an appropriate framework to maintain choice for the benefit of the underlying investor, rather than obliterating dark pools in their entirety.”