Miranda Mizen is principal and head of European research for The Tabb Group. She’s taken a keen interest in the proposed reforms to the Markets in Financial Instruments Directive–also known as MiFID II. Below she talks about how MiFID II, if passed as proposed, would affect dark pools in Europe.
The reforms propose to re-classify broker-dealer dark pools as organized trading facilities. Broker-dealer crossing networks that clear a certain volume threshold would be forced to register as multilateral trading facilities–MTFs–which are the equivalent of ECNs. As a result, they would carry increased regulatory obligations. MiFID II also seeks to bring a degree of transparency to dark pools post-trade and generally curb internalization.
On whether MiFID II is a bellwether for other markets–
We do see and hear a lot more these days about regulators talking to each other and watching each other, incorporating memoranda … It’s interesting, because the U.S. started to look at dark pools earlier than Europe did. But Europe has accelerated and leapfrogged ahead at looking to get the rules tightened up sooner. The regulators are definitely looking at what each other is doing, and talking to each other, because you’ll find references to the U.S. in Europe notes, or you’ll find references to Japan in the market access rules.
So, there’s definitely a much greater element of looking outside one’s borders, particularly since the May 6, because one realizes how quickly things can unravel across continents. Where we come out is you’ll find that regulators look and cherry-pick from others what they think is a good thing to do or how someone’s tightened [regulations] up in a different way.
On Europe speaking through different voices–
Europe is not one voice. You’re never going to find a single voice within a single community. You’ve obviously got your factions. But in Europe, you’ve a huge cultural divide, as well. In the U.K. markets, they’re used to taking risk, used to quote-driven markets, used to innovation. Most of the dark pools come out of the U.K. If you look at all of the big houses that have produced broker dark pools, they’re headquartered in London. And that’s only one group.
You do have different factions in Europe who don’t understand the dark pools, or don’t have enough knowledge and concrete empirical evidence to say: That is the impact of dark pools on price formation. There is an awful lot of lobbying going on, a lot of noise that is not necessarily attached to proof.
On the dangers of restricting dark pools–
It’s very easy to say: it trades in the dark. And if it didn’t, it would trade in the lit. So, dark is taking away from the lit … as opposed to: trading in the electronically dark and the broker dark pools is actually bringing orders away from the traders’ really dark desktops–where they’re never seen by anybody–and putting them into the executable liquidity that is available electronically. And the issue is that if you clamp down on dark pools, you get all sorts of consequences that go with this. First, if a buyside trader doesn’t want to expose his order to the lit, if he doesn’t have a dark pool to put it in, or at least that option, he’s not just going to put it in the lit mkt. He’ll probably keep more of it closer to his chest.
And the guy who rings up and asks for a risk block, and the buyside trader trades on risk with the broker, the broker takes the position. He’s got the same issues that the buyside has, which is why he didn’t trade in the market–he needs to be able to offset that risk quietly and anonymously into the marketplace. If he’s limited in trading into dark pools, with putting that kind of order to find natural offset, then you’re going to find that he’s either going to make risk more expensive, or he’s going to expose himself less–which means the price of capital just went up.
Not all the dark pools are the same, so they definitely shouldn’t be treated the same. There’s definitely a proposal to rein in what you can do. [MiFID II is] a definite look to reduce and restrict what goes on in the dark. But what I don’t see is the concrete evidence as to why that is really, really necessary.
On the Buyside’s view of using dark pools in Europe–
In our organization, we talk extensively with the buyside. And from what they’ve told us, they believe dark pools add value, as well. They use them. If they didn’t think that they protected their order flow, or they couldn’t get better prices in them, they wouldn’t use them, because they have a fiduciary responsibility to get best ex. And more and more have got more used to them, particularly in the last year. We’ve seen that rise across Europe, as people get used to the market structure.
And the buyside, from what we’ve heard in the last year, has found that there’s more liquidity, more people are willing to try it, they get a better match rate, the algorithms are becoming more sophisticated, there are more linking to the dark. But they also limit how much they want to trade in the dark, because they do want that price formation. The lit markets are increasingly important–that’s where prices are formed. It’s a complement, not a supplement. It’s wrong to look at it any other way.
