Equities trading: Mifid review sheds harsh light on dark pools


Louise Bowman
Published on:

New rules boost transparency; Goldman launches MTF

When Goldman Sachs recently announced its intention to launch a new multilateral trading facility (MTF) in Europe it was perhaps a coincidence that the news came in the same month as the European Commission published its Markets in Financial Instruments Directive (Mifid) review consultation document. The migration of dark pool liquidity on to MTF platforms is one of the main changes that the new regulations are expected to trigger, and many in the European equity market see Goldman’s plans as essentially pre-empting this.

But not Goldman itself, which insists this is more than just a regulatory hedge. "This is all about giving end clients access to as deep a liquidity source as possible," says David Shrimpton, incoming COO of Sigma X MTF at Goldman Sachs.

The review of Mifid (or Mifid II as it has been dubbed) has been driven by the EC’s desire for transparency across the system. This means shedding light on private broker crossing networks and essentially subjecting all organized trading facilities (OTFs) to regulation along similar lines. Under the new proposals when a dark pool reaches a certain size threshold (yet to be announced but expected to be around 0.25% of liquidity) it will have to become an MTF and the rules will be tightened on pre- and post-trade transparency. The expectation, therefore, is that many investment banks will convert their existing broker crossing networks to MTFs to offer open access.

Certainly Goldman is not the first bank to do so. Nomura migrated its entire dark pool on to an MTF (Nomura NX) a year ago and UBS has established a separate MTF alongside its existing dark pool. Goldman’s plans are similar to UBS’s in that it will establish its MTF – Sigma X MTF – alongside its existing Sigma X dark pool. The bank is, however, breaking new ground in that it has outsourced the technical running of the platform to NYSE Euronext. "We are cognizant of where the market structure is going," Shrimpton tells Euromoney. "MTFs will be embedded in the European trading landscape and we want to be there. We have a lot of liquidity – trading €500 million a day within the dark pool." He says that the bank is aggregating liquidity sources but housing the MTF in separate technology with regulatory surveillance and governance, which will give confidence to investors.

But if, in essence, Mifid II will align the regulatory oversight of exchanges and MTFs will this not place a heavier regulatory burden on the latter? "There is nothing in the Mifid review about regulatory status that on the face of it will make NX more constrained," explains Andrew Bowley, managing director at Nomura in London. "It is a bit of a myth that there is a massive regulatory burden being an MTF above being a regulated investment firm." Bowley adds that: "A positive market structure clarification would be to make a delineation between an open, nondiscretionary venue and a closed, discretionary venue. The reward for registering as an MTF is that you can provide open access."

But while more investment banks are likely to follow Goldman, UBS and Nomura down the MTF path, not everyone in the market is keen on the development. "We like trading through brokers’ dark pools as well as utilizing capital. We can get business done," says Adrian Fitzpatrick, head of investment dealing at Aegon Asset Management in Edinburgh. "If everything moves on to MTFs it will increase the cost to us and therefore our retail clients. MTFs have to be open to everyone so you run the risk of being picked off by predatory strategies and share prices will move against you." Fitzpatrick argues that investors need access to many different dark pools to get trades done and this will become harder under the proposed regulations (which might incorporate minimum order sizes).

Per Loven, head of corporate strategy at Liquidnet, believes that changes to the pre-trade transparency regime will take place as part of the Mifid review but expects these changes to be marginal and not have a significant impact on large trade execution. "I don’t believe the foundation of pre-trade transparency will change very much", he says. "Some changes will take place, but the Mifid review recognizes that for large orders a pre-trade transparency waiver needs to be in place. Today there is not an efficient post-trade consolidated tape, that will be put in place, which is a good thing and something we support."

Premature assumption

Liquidnet has operated a dark pool since 2002, which was classified as an MTF in 2007. The assumption that all broker crossing networks will inevitably become MTFs under Mifid II could, however, turn out to be premature. "People will make decisions on how they want to be registered," says Jack Vensel, managing director and head of electronic trading at Citi. "Some broker crossing networks that allow access will have to become MTFs but the market needs variation. Broker crossing networks will need to have more visibility on how client orders interact and more definition on how algorithms work. But fund managers will have to make a decision on how much information they want in the marketplace versus how much liquidity they need. They will have more tools but they will have to become more knowledgeable about how brokers work their orders – with choice comes responsibility." When Vensel is asked if Citi will migrate its dark pool liquidity on to an MTF the answer is an emphatic "No – we believe that structuring Citi Match as a broker crossing network provides the best solution for our clients as they attempt to meet their best-execution obligations." And Fitzpatrick at Aegon remains unconvinced that the Mifid proposals will not make his life harder: "Trade reporting rules disadvantage both the buy side and the sell side, especially in the provisioning of risk," he says. "We have got serious misgivings about what they are proposing."