The TABB Group, which over the summer announced that trading in European dark pools had passed 10 percent of total volume, has just issued a report saying the total dark volume now is 11 percent, just a fraction of the 40 percent often bruited about.
Rebecca Healey, European senior research analyst for TABB Group in London said the 11 percent breaks down to 5.05 percent dark MTF and 5.83 percent in broker crossing systems. (It’s always comforting to see accuracy taken to the second place right of the decimal point.)
The TABB Group report, “Dark Matters in Europe: It’s time for the Facts!” addresses regulators’ concerns over dark pools and market transparency.
“We would argue that 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,” Healey wrote, while announcing that a new study ”European Dark Trading: A Question of Clarity,” will be coming out soon.
Dark trading enables sellers to connect to buyers and match orders without exposing their intentions to the public ahead of execution, she said. For institutional traders, it is a way to match trades away from the lit markets to avoid moving prices without breaking large trades down into 100-share bundles and executing them with algorithms.
Healey said that institutional traders are returning to the markets after a four-year decline, but they don’t have a lot of company on trading venues. Thin volumes mean any large trades are readily seen and impact prices. By using data from 10 major European brokers, plus Reuters and Markit, TABB has set the true figure for dark pool activity at 5.05 percent dark MTF and 5.83 in broker crossing systems.
The 40 percent figure for OTC activity in the dark includes anything not executed on an exchange, Healey added. That includes administrative trades, technical trades required under European trade reporting rules or benchmark activity -- trades that offer no access for the buyside.
Within OTC trading, the value of automated dark trading has increased from €40 Billion to €62 billion while as a percenatge of overall European equity turnover it increased from just 3.67 percent to 4.22 percent.
“The concentration in asset management has resulted in fewer, but larger and more challenging trades to be executed in an environment of declining turnover. This coupled with greater automation equals an increase in the volume executed by HFT and market makers and a decrease in the volume executed by long-term fundamental and buy-to- hold investors,” wrote Healey.
She said that while politicians may want greater transparency, trying to push all order flow onto lit venues will harm the very pension funds and retail investors they want to protect.
Healey said that while market participants are willing to work with regulators on some changes to dark pools, current proposals to impose a volume cap on the reference price waiver, together with the introduction of a restricted Organised Trading Facility (OTF) are unlikely to deliver greater transparency.
79 percent of institutional investors perceive the volume cap proposals as detrimental to their ability to execute order flow, she added.
To some degree, dark pools are a response by long-term institutional investors to changes in the markets, from mutual ownership to for-profit exchanges that need to attract participants.
Initiatives to facilitate market-making flow can attract short-term investors that may be damaging for institutional activity. Displaying asset managers’ intentions before they can execute enables shorter-term investors to profit by trading against institutional investors, delivering poor execution and impacts pension fund performance.
At the same time, retail investment has moved from individual shares to mutual funds and ETFs, leading to large order sizes and often homogeneity due to benchmarking. She suggested several changes including improved haromisation of data standards and greater mandated reporting, retention of the equity OTF category with limited categories and order types and requiring meaningful price improvement.
In looking at the cost of trading, regulators have to get beyond explicit costs of execution and consider implicit costs, she added. Some of this can be left to the market -- buy side firms will leave dark pools they think are not providng good pricing.
“There is no other industry in the world where intermediaries would be penalised for endeavouring to get the best price for their client – the end investor,” Healey wrote. “As trading becomes further divorced from the research process, proving best execution has been delivered will be critical.”