Viewpoint : Per Lovén : Dark pools

CURBING DARK TRADING.

In the wake of regulators on both sides of the Atlantic asking questions about dark pool trading and a perceived lack of transparency, Best Execution asked Per Lovén, Liquidnet’s Head of EMEA Corporate Strategy and Product, about the block crossing networks’ views on proposed curbs to dark pool trading.

Where does Liquidnet sit in the dark pool ecosystem?

It’s important to understand that not all dark pools are created equal. Liquidnet is at one end of the spectrum being a buyside-to-buyside block crossing network within the current dark ecosystem.

What we do is connect over 700 of the world’s leading asset managers to large scale equity trading opportunities in 42 markets across the globe. Asset managers rely on us to enter and exit their investments more efficiently – not only improving their own performance, but directly benefiting millions of people across the world who invest in mutual and retirement funds. We offer trading predominantly at the midpoint (approx. 93% of trades) with no, or minimal market impact and deliver an average price improvement of around 95* basis points to our members.

At the other end of the spectrum are the exchanges and sellside trading venues (MTFs) such as LSEG’s Turquoise and BATS’ Chi-Delta, which each have an average trade size above EUR6,000. In the middle, between the two sit other dark operators such as buy and sellside MTF trading venues: ITG Posit and Instinet BlockMatch, which deliver an average execution size of over EUR9,000, and broker crossing networks (BCNs) run by banks, such as UBS Pin, Credit Suisse, Citi Match, etc, delivering EUR3,000-EUR10,000 average execution sizes to their clients. Liquidnet’s average execution trade size in Europe stood at EUR952,000 this January (source: Rosenblatt Securities – ‘Let there be light’, Q2 2013), which represents 120 times the average execution size in all dark pools. The next largest was the SIX Swiss Liquidnet Service (SLS), which is run by Liquidnet with the SIX Swiss Exchange, with EUR539,000.

So, you can see the value proposition for Liquidnet is very different compared to the other dark venues in the market.

Can you summarise the proposed limits on dark pools and what concerns do you have as regards the potential impact on clients?

In Europe there are two proposals under the MiFID II/MiFIR umbrella, with a European Parliament proposal on one hand, and the European Council’s position on the other. We are comfortable with the European Parliament’s proposal and think it drives dark trading in exactly the right direction, namely reducing market impact, and/or providing meaningful price improvement – a direction that is focused on pushing smaller orders towards lit environments to improve price discovery.

There are three relevant waivers proposed by the European Council that can be used for trading in the dark (e.g. a large-in-size waiver, a reference price waiver and a negotiated trade waiver). It is generally agreed that everyone wishes to maintain the large-in-size waiver as it is recognised as delivering real value to investors. The reference price waiver means market participants can execute in dark pools using prices formed in lit venues as a reference.

The Council has proposed a trading cap for the use of the reference price and negotiated trade waivers, whereby if a specific name on a venue sees more than 4% of overall trading conducted on it under these waivers, then the instrument in question can no longer be traded under these waivers for six months. And, if more than 8% is traded under the waivers in a specific name on all trading venues across the European Union over the previous 12 month period, then it cannot be traded under these respective waivers for a period of six months. We are less comfortable with this proposed trading cap.

As a firm we do not believe we will be massively impacted and the valuable services we provide to our global asset manager member base are unlikely to be affected. The dark trading landscape as a whole could be heavily impacted, although the exact degree will remain unknown until a consensus is reached through the trialogue negotiations that are currently taking place in Brussels.

Our concern lies with regard to our members. The fact is that we do not trade 100% of our clients’ orders, so consequently it could prove less efficient and more costly for members to trade as other dark pools that are likely to be heavily impacted.

What are your views on Article 4 of MiFIR (regarding the detailed conditions for waivers from pre-trade transparency)?

We believe that exemptions from pre-trade transparency should be conditional upon a value being provided to long-term investors (specifically European savers) over and above what is available on a displayed market.

The large-in-size waiver provides market impact cost savings. The reference price waiver, if restricted to trading at the mid-point, provides price improvement. Both waivers should be maintained as they benefit long-term investors. We support the proposal of the European Council that requires trades based on the reference price waiver to be executed at the mid-point, ensuring that value, in the form of material price improvement, is provided to long-term investors.

In both Australia and Canada, recent rulemaking that is consistent with our proposal has resulted in an increase in lit-market trading and a decrease in trading in broker-operated dark pools. After the implementation of the Australian Securities and Investments Commission (ASIC) price improvement requirement on 26 May, 2013, market share of lit venues in Australia increased from 71.6% to 73.7%, and non-block, dark pool internalised volume decreased from 15.3% to 11.2%.

Tabb Group, a financial markets research and strategic advisory firm focused exclusively on capital markets, similarly reports with respect to Canada that “the October 12, 2012 implementation of the dark order amendments led to a significant drop in dark pool volumes.”

This clearly demonstrates these new policies are working in terms of helping deliver best execution for institutional investors and provide the solution the European policy makers are looking achieve through their revisions of MiFID.

Is Liquidnet a lone voice, or is there an effective lobby group?

Our approach is supported by the European Fund and Asset Management Association, the representative trade group for the European investment management industry, which, in a recent joint letter to the European Parliament, Council and Commission, wrote in support of off-exchange trading “when it offers meaningful price improvement for investors.” Other signatories to the letter included institutional investor trade groups, such as: the Association of British Insurers, Assogestioni, and the Investment Managers Association; Dutch pension fund manager APG; leading investment management firms such as Allianz, BlackRock, Fidelity and State Street; and the London Stock Exchange.

Liquidnet is not a lone voice.