TABB Warns Regulators Further Dark Pool Rules Risk Hurting Investors

(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.”

Never miss a story — sign up for CIO newsletters to stay up-to-date on the latest institutional investment industry news. 

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.

(November 14, 2013) — Investing in companies with strong corporate governance principles will lead to a stronger rate of return, according to new evidence from research firms Inalytics and PIRC.

At a time when environment, social, and governance investing is becoming increasingly popular, PIRC and Inalytics’ report has claimed the return profile of these types of corporates outperforms the index by 13.9%.

The foundation for the analysis was PIRC’s scoring of companies’ governance profiles, which are based on a number of factors including the independence of their auditing process and their disclosure of executive pay. These different criteria are combined to rank companies as high, medium, or low risk.

Of the 423 Companies analysed, the firms which are ranked “high-risk” by PIRC underperformed the index by an average of 4.1% over a 23-month period, but those ranked “low-risk” outperformed the same index by 13.9%.

Want the latest institutional investment industry news and insights? Sign up for CIO newsletters. 

The effect is most pronounced at the small cap end of the equities market: ‘low-risk’ firms outperformed the index by 15%, “medium-risk” by 8.15%, while “high-risk” companies underperformed by 0.4%.

“For small caps, governance may have a larger effect because the decisions and behaviour of management are more critical in smaller organisations,” said Rick DiMascio, CEO of Inalytics.

The phenomenon was far less evident when assessing large cap stocks however. “Low-risk” companies were found to have underperformed by 1.6% and “high-risk” companies underperformed 2.2%, but “medium-risk” companies outperformed 0.4%.

DiMascio confessed that the reasons for the reduced impact of governance were “as yet unclear”, adding: “Perhaps it is because governance’s effect is diluted for large companies who have many factors impacting their performance.”

Despite this variance Inalytics is confident the research will help pension funds understand the influence governance has on their investments. The research will be continued, using the Merseyside Pension Fund’s portfolio.

“The on-going research will compare the fund’s portfolios to see how performance is affected by governance ranking,” said DiMascio.

“Clients are using this information to assess the overall profile of their portfolios and gauge whether their managers own high or low risk companies from a governance perspective. We are confident that this research area will provide greater understanding of the impact of corporate governance in the future.”

For further information on the process and methodology, click here.