“Europe needs effective, understandable and deliverable changes to the current framework.”

“The current SIs regime is complex and unclear.”

“The new amendment minimises supervisory divergence and bans the payment for order flows across the Union.”

Dark pool caps scrapped
The report also recommends removing the dark pool limitations brought in under Mifid II, in a move that could see the EU move to compete with the UK for dark trading volumes. “These caps were set arbitrarily and proved to be of limited utility, and their removal would reduce complexity and align the Union with international practices,” said Hübner. 

Currently the Union has far lower dark pool allowances than the UK, which has sought to reinvent itself post-Brexit as an attractive destination for dark trading, while the EU has prioritised transparency within lit markets.

Convergence over divergence
Banning PFOF and scrapping dark pool caps would, notably, bring the EU closer to the UK in two key areas of regulatory focus – a rare example of convergence (for a change), compared to divergence.

“It’s positive to see a more pragmatic response to the EU Commission’s proposals, which could see Europe row back from some of the more restrictive measures tabled in November.”

“It’s positive to see a more pragmatic response to the EU Commission’s proposals, which could see Europe row back from some of the more restrictive measures tabled in November and ultimately lead to less regulatory divergence between the two markets,” commented James Baugh, head of European market structure at Cowen, speaking to The TRADE.

“I also see support for a real-time pre-trade tape as big step in the right direction. That said, PFOF remains an area of uncertainty and with Germany still pushing back on an outright ban, this will have to run its course.”

Nuts and bolts
The report contains a number of other amendments, including:

 – Reinstating the exemption for non-financial entities (NFEs) who execute transactions on trading venues.
 – Subjecting investment firms (in addition to trading venues) to data quality standards when submitting market data.
 – Requiring all market operators (and investment firms operating an MTF or an OTF) to obtain an ISO legal entity identifier (LEI) for all traded securities, in order to ensure an even playing field between EU and non-EU issuers. 
 – Confirming the removal of RTS27 and 28 with regards to reporting obligations. 
 – Adding a requirement for giving at least two “materially active” liquidity providers the opportunity to interact with independent order flow with regard to price formation.
 – Allowing, for third country shares, the use of the prevailing tick size on the main exchange, in order to boost competitiveness. 

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Trading in dark pools and periodic auctions can reduce transaction costs while more transparent venues incur higher costs and implementation shortfall, the research from the Financial Conduct Authority (FCA) said.

In one example, the FCA said that when dark trading is not subject to bans a 10% increase in the proportion of a parent order executed in a dark venue reduces implementation shortfall by 0.97 bps.

Executing on periodic auction venues produces a similar reduction in transaction costs, with savings of 1.17 bps for a 10% increase in proportion traded, the analysis of more than 58,000 parent orders from almost 1,000 market participants found.

“We find venue selection decisions matter,” the FCA’s paper said. “We find that the higher the proportion of dark or large-in-scale dark executions in the parent order, the lower its implementation shortfall. We also find that periodic batch auctions reduce implementation shortfall when dark pools are banned.”

The findings contradict similar research from the EU which has made efforts to restrict trading in dark pools to increase activity that occurs on pre-trade transparent or ‘lit’ venues. The EU introduced double volume caps (DVCs) in 2018 under MiFID II that trigger bans on dark trading when a transaction reaches a certain size.

The European Securities and Markets Authority (ESMA) stated in a review of MiFID II that the DVCs have had a limited, but overall positive effect on market liquidity. Market participants, however, have been vocal with criticisms on the move by regulators in Europe to curb dark trading, which they say allows for minimal market impact and often the best price for clients.

Similarly, periodic auctions came under intense regulatory scrutiny after ESMA expressed concerns that the venues were being used to circumvent the rules on dark trading. Amid fears the EU watchdog would ban periodic auctions, ESMA eventually opted to make changes to how the systems should operate.

The UK’s regulator has already said it will lift restrictions on dark trading for investors in a bid to attract more business in a post-Brexit world. A post-Brexit equivalence agreement was also reached on stock exchanges between the UK and Switzerland, which will increase activity for Swiss stocks on UK venues.

“It is likely that the DVC policy did not affect transaction costs because substitutes like periodic auction-based venues are available,” the FCA paper added. “Importantly, after the ban is lifted, we find participant volume moves back to dark pools, implying perhaps that participants prefer dark pools to periodic auctions when both options are available.”

The post Trading in dark pools and periodic auctions lowers execution costs, FCA paper concludes appeared first on The TRADE.

The Securities and Exchange Commission (SEC) said in a statement that investors were ‘misled with assurances’ that HFTs were not allowed to trade in Citi Match, Citi’s premium-priced dark pool, via Citi Order Routing and Execution (CORE).

In fact, the SEC found that two of Citi Match’s most active users qualified as HFTs and executed more than $9 billion of orders in the dark pool.

“Market participants deserve to make informed decisions about where they execute their orders,” said Joseph Sansone, chief of the SEC enforcement division’s market abuse unit. “All trading venues, regardless of their trade volume, must ensure that their users have accurate information, particularly about key issues like order routing.”

Investors were misled about the HFTs operating in Citi’s dark pool for over two years, with almost half of all Citi Match orders being routed to and then executed in other dark pools and exchanges, according to the SEC.

Furthermore, Citi sent trade confirmations to investors which suggested orders had been executed on Citi Match, when they had actually been executed on an outside venue.

Earlier this year the SEC took steps to adopt new rules for equities dark pool operators to significantly increase transparency and oversight of how they operate.

The new rules proposed by the regulator would require dark pool operators to disclose information on its broker-dealer activities so that market participants can understand how orders interact, match and execute.

Citi did not admit or deny the SEC’s finding related to Citi Match and CORE, but agreed to pay disgorgement and prejudgement interest totaling more than $5 million, and a penalty of $6.5 million. CORE will also pay a penalty of $1 million.

In April, Citi was fined HK$4 million by authorities in Hong Kong for regulatory breaches again related to its dark pool, including incorrect system settings which saw certain investors gain access to the venue without being assessed a qualified investors.

The post Citi fined $12 million for misleading investors about HFTs in its dark pool appeared first on The TRADE.

The trade reporting facility, which is operated alongside the Financial Industry Regulatory Authority (FINRA), will increase fees for dark pool transactions as of 1 September in response to the rising costs of operation.

Nasdaq and FINRA said in a regulatory filing that dark pool trades reported to their trade reporting facility have surged 47% since 2012, but at the same Nasdaq’s costs for running the facility have increased 16%.

The exchange added that a re-calibration of fees for reporting will help it to manage costs more efficiently as trading volumes rise, while also providing opportunities to upgrade the technology and performance of the reporting facility.

“The participation fee will help defray certain shared and common costs associated with the operation of the FINRA/Nasdaq trade reporting facilities, including overhead costs and the costs of developing, maintaining, and upgrading shared technology,” the regulatory filing said.

“Nasdaq believes that all users of the FINRA/Nasdaq trade reporting facilities – both large and small – should bear at least some responsibility for the upkeep.”

Rules already introduced by US financial watchdog the Securities and Exchange Commission (SEC) mean that all transactions, including on-exchange and dark pool trades, must be reported to a consolidated data feed via a trade reporting facility.

The fee hike, which has been estimated to total around $3.5 million per year, could see some firms change reporting behaviour and possibly incur lower reporting costs based on the new thresholds.

Although Nasdaq and FINRA warned that firms could also move reporting to another facility, and investors could incur the costs of the fee increase if costs are passed down to clients.

“Nasdaq advises that it expects to earn a profit from the proposed changes, but it believes that such profit represents a reasonable return on its work in support of and investments in the FINRA/Nasdaq trade reporting facilities, and that the extent of such profit will be subject to and constrained by competitive pressures.”

The post Nasdaq ups reporting fees for dark pool trades with FINRA appeared first on The TRADE.

ITG has said it is currently in discussions with the US financial watchdog regarding a possible $12 million settlement relating to an investigation into certain features of its dark pool POSIT.

The agency broker stated that the issues being investigated originated in 2010, or earlier, and is focused on the US POSIT business, not regional dark pools or other ITG businesses.

The investigation is looking at technologies used for POSIT between 2010 and 2014 that affected some clients’ ability to interact with order flow and access to POSIT data, ITG said, but it does not involve proprietary trading, as it did in a previous settlement in 2015.

The Securities and Exchange Commission (SEC) handed ITG a record fine of $20 million in 2015 relating to a proprietary trading pilot programme which ran within POSIT from 2010 until mid-2011.

ITG said it has taken “meaningful remedial actions” during the course of the SEC’s investigations by imposing further limitations on access to US POSIT data and improving the operation of the dark pool.

“Across the firm, we are deeply committed to operating with the highest level of integrity,” ITG’s CEO, Frank Troise, said about the settlement. “We are working towards a potential SEC settlement of these issues so we can focus on our agenda of technology-driven innovation and world-class client service.”

Taking the potential settlement into account, ITG posted a net loss of $3 million in the second quarter this year and adjusted net income of $9.2 million, compared to GAAP net income of $4.6 million in the second quarter last year. Revenues were also up in the second quarter from $121.6 million in 2017 to $128.5 million.

“As we move into the final quarters of our Strategic Operating Plan, we are seeing clear results, with adjusted net income in the second quarter of 2018 nearly double that of the second quarter of 2017,” Troise added.

“Our goal is to deliver client value as the best operator in our core business areas of execution, liquidity, analytics and workflow technology.”

The post ITG warns of potential $12 million US dark pool settlement appeared first on The TRADE.

The US financial watchdog has voted to adopt new rules for equities dark pool operators which will significantly increase transparency and oversight of how they operate.

A statement from the Securities and Exchange Commission (SEC) explained the rules, which apply to dark pools trading stocks and shares off-exchange, will require dark pool operators to disclose information on its broker-dealer activities so that market participants can understand how orders interact, match and execute.

Dark pools, also known as alternative trading systems (ATSs), have been the subject of mass controversy and debate in recent years, with financial regulators worldwide looking to clamp down on failures and potential manipulation by banks across the venues.

Major financial institutions have been handed record fines for mismanagement of dark pools. Deutsche Bank was ordered to pay a $37 million by the SEC following misstatements and omissions related to the marketing of its dark pool equities order router.

Credit Suisse and Barclays also settled similar investigations by the SEC into their dark pools by agreeing to pay a combined $154.3 million in fines. Both investment banks admitted to making false statements in connections with the marketing of their dark pools and other electronic trading services.

Industry concerns around dark pools, including a lack of transparency on where orders are routed, information leakage and potential internal broker preferencing, remain concerns for many market participants today.

Brokers operating dark pools in the US will have to use a public filing, Form ATS-N, to disclose the required information on their management and clients as of January 2019, the SEC said.

“I applaud the staff’s retrospective review of our regulation of ATSs,” said SEC chairman Jay Clayton. “I agree that promoting greater transparency in order interaction, matching, and execution will help empower investors and their intermediaries to find those trading venues that best meet their trading and investing objectives.”

The post US dark pools set for transparency overhaul appeared first on The TRADE.

The survey of traders in shares, fixed income, structured products and exchange-traded funds (ETFs) suggests that traders are divided as to where dark liquidity on capped stocks will migrate towards instead of lit markets.

Just over 30% of respondents said it will migrate to block trading venues, while 23% said systematic internalisers (SIs) and 20% predicted periodic auctions.

“This variance in responses highlights the reigning uncertainty among traders,” commented Tony Shaw, director of the London office for securities & exchanges at SIX, commented. “Over time, market developments will provide more conclusive answers on the success of MiFID II.”

The debate around where order flow will shift towards post-MiFID II has long-been debated among industry participants. Early indicators suggest that between them, periodic auctions, SIs and block trading venues have swept up dark liquidity since the regulation was introduced on 3 January this year.

Statistics from Fidessa published earlier this month showed that block trades now account for a record half of all dark trading. At the same time, research from ITG revealed that the double volume caps under MiFID II have caused a material decline in dark multilateral trading facility (MTF) volumes since they were introduced in March.  

SIX Group’s survey found that despite a lack of confidence on a migration towards lit markets, a majority of 70% of traders agreed that MiFID II has  made trading more transparent.

Furthermore, although MiFID II remains a concern among the trading community, it is no longer considered to be the biggest challenge in 2018. Those surveyed who said regulation like MiFID II was the biggest risk fell to 46% this year, compared to 73% last year.

“Despite the optimism of some traders, there is no consensus on whether MiFID II can be deemed a success,” Shaw added. “Our research demonstrates a large difference of opinion among market participants.”

In terms of challenges of complying with MiFID II, 86% of traders stated that reporting is the most problematic, with 50% citing transaction reporting and 36% said best execution reporting.

The post Traders not convinced of shift to lit markets under MiFID II appeared first on The TRADE.

The trading venue said following the European Securities and Markets Authority’s (ESMA) second double volume cap calculations, the bans will be implemented over a six month period, effective from 13 April.

UBS added that it wanted to remind its members that the capped instruments remain available for trading under the large-in-scale waiver.

MiFID II introduced the DVCs for dark venues, triggering bans on certain types of trading when a transaction accounts for 4% of the total activity on a single dark venue, or 8% of total trading market-wide.

The EU financial watchdog is pushing for more activity to be traded on lit venues and exchanges where pricing is fully transparent. Dark pool operators worldwide have been hit with some of the largest fines on record in recent years amid allegations of misleading investors and manipulation.

Just one week after MiFID II was implemented across Europe, ESMA was forced to delay the implementation of dark trading rules due to incomplete data from trading venues. Without the correct data, the regulator said it was unable to comprehensively calculate the DVCs.

The first published data on DVCs from ESMA revealed a total of 744 instruments in January and 643 in February hit either the 4% or 8% threshold.

Industry experts have questioned whether the market will strive to stay below the threshold once the six month bans are lifted, or move away from dark venues heralding a permanent change in market behaviour.

The post UBS MTF lists more than 50 stocks suspended by MiFID II DVCs appeared first on The TRADE.

In the previous edition of The TRADE magazine, published just weeks before MiFID II came into effect on 3 January, industry participants and experts dissected the block trading landscape and made predictions on the migration of order flow from BCNs. One trend became clear – periodic auctions, LIS venues and finally SIs were the venues to bet on in a post-MiFID II world, not necessarily on-exchange or lit venues.

In a Liquidnet member presentation in February the firm said that, at a high level at least, there hasn’t been a significant difference in dark and lit activity, and lit volumes experienced no major change since 3 January. Instead, Liquidnet saw that periodic auction volumes had exploded, LIS activity had continued to increase and SIs even snuck in to steal a slice of the pie.

Less than two weeks after MiFID II finally came into force, Neil Bond, head of trading at Ardevora, offered The TRADE his insight as to where activity had migrated in those early days of the new regime. “Following the closure of BCNs, it seems periodic auctions have absorbed the majority of buy-side to buy-side crossing that was initially going through those venues,” he said.

Bond’s observation is clearly validated by a surge in volumes across various periodic auction venues during MiFID II’s infancy. The Cboe Periodic Auctions book, for example, saw a record month of trading volume totalling more than €6.5 billion during January, and average daily notional value (ADNV) traded reached €296 million, a massive 885.3% increase compared to the fourth quarter in 2017.

Dark delay and data difficulties

Periodic auctions are widely expected to sweep up even more order flow following the introduction of the double volumes caps (DVCs) for dark pools, which were delayed just one week into the MiFID II regime until 12 March by the EU markets watchdog. The European Securities and Markets Authority (ESMA) said in a statement released on 9 January that the data received from trading venues since MiFID II went live six days prior was insufficient and did not allow for a ‘meaningful’ and ‘comprehensive’ calculation of the planned DVCs.

“The ban on BCNs has helped to boost periodic auction volumes,” says Anish Puaar, market structure analyst for Europe at Rosenblatt Securities. “Most periodic auctions offer broker priority which gives brokers a low-cost, transparent way of matching client orders that used to reside in BCNs.”

Even this early into the new regulatory regime it has become clear that data and reporting are significant issues to address. Confusion around SI reporting requirements has skewed the data, and a large proportion of transactions that were previously reported as over-the-counter (OTC) are now being reported as SI activity. It’s the same story with periodic auctions: what percentage of transactions executed through auctions is price forming or pre-matched?

As it stands, the data is simply not granular enough and various different parties are coming up with their own estimates instead, making it near impossible to draw any firm or definitive conclusions from the available data sets.

Regulators including the UK’s Financial Conduct Authority (FCA) are supposedly keen to dive into the details of orders executed on auctions, prompting speculation that there could be tighter restrictions on how they operate in the future.

“With both SIs and periodic auctions, it is quite difficult to figure out what is addressable liquidity and what isn’t,” says Tim Cave, a European market structure analyst at TABB Group. “It’s really up to the industry to come together and standardise how transactions are reported, particularly through SIs, to provide a better understanding of where liquidity is residing. Overall, there hasn’t been a huge shift towards lit venues which was of course the intention of MiFID II, so regulators will be watching this closely.”

Ardervora’s Bond also raised doubts over the early buy-side adoption of SIs. “I believe SIs have absorbed the rest of that activity and internal SIs are probably trying to get as much as possible done,” he said. “While larger institutions test the waters with external SIs, I don’t think the buy side will fully embrace external SIs until they have solid data on performance on those venues. They are being used, but not widely across the buy side.”

Cave adds the DVCs will see buy-side firms taking a closer look at SIs and there should be more execution data ready for analysis. “SIs are a new way of trading for the buy side and, as with any new venue, they want to able to analyse execution quality before utilising them properly to ensure they are offering best execution,” he says.

Teething problems

Block trading and LIS venues have certainly thrived in the new, post-MiFID II world. Fidessa’s Top of the Blocks report reveals just how far block trading has come over the past year alone, as the proportion of dark traded-as-LIS blocks reached a record 28.7% on 12 January compared to 12% in January last year.

“LIS activity doubled last year and we think block trading will continue to grow this year,” adds Rosenblatt’s Puaar. “However, there is generally a natural ceiling to the proportion of trading done in blocks. The increasing number of block-trading venues means it may become even harder to match large trades.”

So have volumes moved onto lit venues as MiFID II intended? It would appear not, or at least not yet anyway, and as experts have pointed out, the introduction of DVCs will likely see firms consider the once-feared SIs as a genuine alternative rather than moving volumes onto lit exchanges.

There are similarities that can be drawn between BCNs and SIs, as BCNs were too often misunderstood and feared by market participants in the same way SIs are now. But there are other aspects to using SIs that are daunting to buy-siders; a lack of data and complicated reporting in particular, as well as a bad reputation following rumours of plans to circumnavigate MiFID II guidelines via a trading loophole.

The industry is mere weeks into the new regulatory landscape and any significant depth of change will not occur overnight. Metamorphosis on such a monumental scale will always throw up issues and teething problems are to be expected. Nevertheless, a tangible shift towards lit venues is certainly not happening yet, and with a flurry of new execution venues available under MiFID II which are struggling to provide coherent and granular data, it could be argued that the regulatory regime has in some ways created less transparency and more venues alternative to lit ones. 

Questions remain as to when, or indeed if, the buy side will fully embrace and adopt SIs as an execution venue. While periodic auctions are poised to continue growing, block trading activity will likely hit a roof at some point, leaving on-exchange as the last venue to see any tangible increase in activity. This could happen when the MiFID II RTS 27 best execution reports are made public in June. Although should that not come to pass, the industry can expect ESMA to revisit MiFID II’s rules around trading venues to make further adjustments. Just don’t mention MiFID III.

The post Moving towards the light appeared first on The TRADE.

ESMA has released data on equity and equity-like instruments that hit the trading threshold, meaning they cannot be traded in dark pool venues.

A total of 744 instruments in January and 643 in February this year hit either the 4% or 8% threshold according to ESMA’s data.  Securities which hit the threshold will be suspended from trading in dark pools for six months as of 12 March.

Combining the statistics for January and February 2018 represents 2.5% of all equities ESMA lists in its transparency calculations, although it represents 35% of all liquid instruments listed where the DVCs will matter most, according to Christian Voigt, senior regulatory adviser at Fidessa.

Voigt added that when the bans are lifted after six months trading could revert to the old ways as the market strives to stay below the threshold, or it could herald a permanent change in market behaviour and a move away from DVCs. “In which case, you might wonder what the difference is between the DVC and a simple ban,” he concluded.

For Alasdair Haynes, CEO of Aquis Exchange, the caps will result in a move towards lit venues with liquidity and toxicity driving the migration.

“Regulators are making very clear their intention to create greater transparency and drive certain types of trading onto lit venues and ultimately that is good for markets,” Haynes told The TRADE. “The long-term winners from this ruling will be venues like Aquis that can offer good liquidity combined with low toxicity.”

MiFID II, which came into force on 3 January, introduced the DVCs for dark pools, triggering bans on certain types of dark trading when a transaction accounts for 4% of the total activity on a single dark venue, or 8% of total trading market-wide.

Various studies have shown a significant amount of securities would hit the MiFID II thresholds, with senior market participants warning the caps would be detrimental to the market by restricting one of the most effective methods of trading.  

Duncan Higgins, head of electronic products at equities broker ITG, told The TRADE that UK blue chip stocks are set to be hit hardest by the caps according to the data.

“Crucially, 85 UK blue chips of 101 stocks in the FTSE 100 will hit the 8% cap. Judging by the information from ESMA, German index names appear to be the least affected of all the stocks in Europe. When it comes to the capped stocks which have the highest amount of trading activity across Europe, major UK names such as HSBC, AstraZeneca and Vodafone will be hit,” Higgins said.

Major breaches

Research from Rosenblatt Securities carried out  prior to the implementation of the DVCs predicted that up to 89% of stocks traded in the FTSE 100 and FTSE 250 would breach the market-wide caps.

Even the Financial Conduct Authority (FCA) in the UK highlighted that dark trading begins to negatively affect market quality between 11% and 17% of market turnover, a much higher level than MiFID II’s proposed dark pool caps.

The FCA warned it is important that “policy makers take care not to eliminate the market quality benefits of dark trading by arbitrarily imposing uniform dark trading restrictions for all stock sizes”.

“There have been many studies to try and estimate the amount of stocks that will be impacted by the caps, but with very little information on how the calculations are exactly going to work,” said Gareth Exton, head of execution consulting at Liquidnet. “But now we will find out the impact these caps are going to have on the trading landscape.

“What will be interesting post the introduction of the caps, is where liquidity moves to and the effect it may have on clients’ execution performance.”

Just one week after MiFID II was implemented across Europe, ESMA confirmed the delay of the dark trading rulesdue to incomplete data from trading venues. Without the correct data, the regulator said it was unable to comprehensively calculate the DVCs.

Under MiFID II the EU watchdog is pushing for more activity to be traded on lit venues and exchanges where pricing is fully transparent. Dark pool operators worldwide have been hit with some of the largest fines on record in recent years amid allegations of misleading investors and manipulation.

The post Dark pools hit by MiFID II caps after delay appeared first on The TRADE.