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As the SEC 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% of daily turnover in major European markets, forecast to increase 7% in 2010 as buy side traders acquire the knowledge, tools and insight to increase their confidence to trade where they cannot see.
According to Miranda Mizen, a principal at TABB and author of a new research report, “Trading in the Dark in Europe: Choice and Complexity on the Cusp of Change,” trading in the dark is just scratching the surface of its potential in Europe.” 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 Group 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.According to Mizen, 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 (MTFs) 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.
Knowledge, tools, visibility and standardisation create greater demand for differentiation and innovation, and this will result in the concentration of liquidity in the more sophisticated environments. If providing transparency in the marketplace and shedding light on the mechanics sounds juxtaposed when it comes to dark liquidity, it is because this is a work in progress. “The best is yet to come as innovation takes off in earnest and the stakes are raised to attract order flow into the dark; but only the most sophisticated will be able to show the kind of value for which the buy side is willing to pay a premium,” concludes Mizen.
The 25-page report with 12 exhibits is an in-depth analysis of interviews with 16 head buy-side traders in Europe and the US, and incorporates data and analysis on dark trading from TABB Group’s “European Equity Trading Study 2009: Counterparties, Capital and Control,” where 53 head traders across the major markets of Europe were interviewed. It covers estimated daily turnover in Europe; dark environments throughout the execution chain; multiple types of dark environments; protecting order flow through three areas of innovation, e.g., functionality, aggregation and visibility; ownership structures for dark environment; choosing between trading in lit or dark environments or both; and estimated growth of dark trading in Europe, 2005-2010.
The report can be downloaded by TABB Group Research Alliance Equity clients and pre-qualified media at https://www.tabbgroup.com/Login.aspx. For an Executive Summary or to purchase the report, go to http://www.tabbgroup.com or write to info@tabbgroup.com.
