(November 14, 2013) — Proposed regulatory changes to dark pool investing will lead to higher overall trading costs and limit investor choice, according to the TABB Group.
The research firm has issued a warning to regulators that its current proposals to impose a volume cap on the reference price waiver and introduce a restricted Organised Trading Facility are unlikely to deliver the greater levels of transparency they desire, and could damage investors’ returns.
“Increased transparency in the dark is welcomed by European institutional investors but within a carefully considered and calibrated framework,” said Rebecca Healey, senior research analyst at TABB Group Europe.
“If regulations are introduced that restrict valuable choice, the outcome of current proposals could be counterproductive and harmful to end investors. As it stands, increased regulation of dark pools will result in equity orders staying on the blotter longer, leading to higher overall trading costs, impacting small and mid-cap stocks in particular.”
Dark pools trading—which uses electronic venues to enable sellers to connect with buyers and match orders without exposing their intentions to the public ahead of execution—has been scrutinised by regulators on both sides of the Atlantic for years.
By sending trades through private exchanges, investors can execute large orders at a fixed price. In the simplest terms, a pension fund can use a dark pool to sell a big equity position without sending the price of those shares down as they carry out the trade, and vice versa.
Before dark pools existed, institutional investors had to hide sizeable orders by breaking them into smaller parcels, making the process more time consuming and producing the risk that the market could move against their position before they had completed their transactions.
Regulators are troubled about the lack of transparency surrounding these transactions however, and have concerns about investors having confidential information abused by the venue operators where these dark trades take place.
In Europe, 11% of European trade sharing volume is now conducted using dark pools according to TABB. The figures for TABB’s study are based on contributions by eight European brokers and data providers Thomson Reuters and Markit, making it one of the most extensive surveys of European dark pool trading.
The research firm also found that alternative trading venues operated by companies such as Bats Chi-X Europe, Goldman Sachs Sigma X, UBS MTF, Turquoise, and Instinet have taken their market share from 3.2% to 5 % in the last 12 months.
The timing of TABB’s research is crucial—the European Commission and the European Parliament, along with its Council of Ministers, are finalising the new rules for dark pool trading during the next few weeks.
TABB said some of the apprehensions around dark pool trading have come from a misinterpretation over how much of it is actually being done. Some media outlets have cited a figure of 40% of trades being done in this way, but TABB has claimed that this figure represents all over the counter activity ie anything that is not executed on an exchange.
Any political pressure to force greater levels of transparency on this type of trading would harm the very pension funds and retail investors they want to protect, TABB said.
“Critics say the lack of public information on trades as dark volumes grow makes price discovery harder. Yet market participants disagree,” said Healey.
The increased usage of processes such as fix protocol tagging and venue analysis allows greater post-trade transparency, which in turn provides the correct level of pre-trade transparency without negatively impacting the institutional trader in the process, she argued.
“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,” she concluded.
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