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The future of dark liquidity in Europe

Published in Automated Trader Magazine Issue 41 Q4 2016

The dark trading landscape faces fundamental change once again. The changes in MiFID 2/MiFIR, including dark volume caps, will profoundly affect most dark trading activity, fundamentally altering how institutional investors interact with hidden liquidity.

Harald Carlens


Harald Carlens joined ITG in 2012 and is a quantitative analyst specialising in algorithmic execution products for European markets.

Duncan Higgins

Duncan Higgins joined ITG in January 2010 and is responsible for ITG's electronic product and business strategy for European markets.

The impending restrictions will curtail many segments of dark trading, but they will not eliminate the need for participants to minimise market impact by executing block trades in the dark. The European Securities and Markets Authority (ESMA) has given special consideration to what it calls "large-in-scale" (LIS) trades and will allow them to remain unaffected by the caps. The onus is now on the industry to trade in a way that is within the new rules while it makes use of the exemptions from the caps.

With the delay in implementation, the industry has been amassing an arsenal of solutions to a problem that will not arrive until 2018. This article examines changes in dark trading legislation from MiFID 1 to MiFID 2, the growth of block trading trends in recent years and market initiatives that have emerged as result of the coming restrictions.

MiFID 1 and pre-trade transparency

variety of operators through three types of trading venues: regulated markets (RM), multilateral trading facilities (MTF) and systematic internalisers (SI). Any transactions concluded outside a RM or a MTF, including those taking place on a SI, were considered over-the-counter. To ensure effective price discovery, transparency requirements were imposed. Pre-trade transparency rules under MiFID 1 dictated that recognised trading venues publish information on the current bid and offer prices and the volume available at those prices in their systems unless venues were made exempt by the application of certain waivers.

Four distinct pre-trade transparency waivers were introduced, any of which would allow a venue to be exempt from the pre-trade transparency obligation. These waivers present the key to successfully understanding the impact of MiFID 2 on the dark trading landscape, so we briefly lay out their definitions below.

Reference Price Waiver (RPW)

Most dark MTFs currently operate under the reference price waiver (RPW). When orders are matched, executions take place at a price derived from an external reference source such as the primary market best bid/offer or consolidated European best bid/offer. Under MiFID, MTFs are able to trade at the bid, mid and offer.

Negotiated Trade Waiver (NTW)

The negotiated trade waiver allows negotiated trades to be concluded off order book, provided the transaction occurs at or within the current volume-weighted spread or the price is subject to conditions other than the current market price of the share, such as a VWAP transaction.

Order Management Facility Waiver

The order management facility waiver covers a specific scenario in which orders are held in an order management facility maintained by an RM or MTF, pending disclosure of those orders to the market. Use cases of this waiver include iceberg and stop-loss orders.

Large-in-scale Waiver

For very large orders the large-in-scale waiver allows dark trades to take place at any price. The definition of 'large' is stock-specific and goes up to 500,000 EUR for large caps. This waiver has had relatively limited use in Europe until now because of the flexibility of the reference price waiver.

The growth of the dark MTF market in Europe since January 2010, shown in Figure 01, demonstrates the widespread use of these waivers.

The growth of the dark MTF market in Europe since January 2010, shown in Figure 01, demonstrates the widespread use of these waivers.

In addition to the waiver exemptions for MTFs and regulated markets, brokers have been permitted to operate systematic internalisers and broker crossing networks (BCNs) with few restrictions. The BCN framework has allowed brokers to transact significant volumes internally, ostensibly matching order flow "in the process of executing client orders". Brokers operating SIs technically have been subject to quoting obligations, although these have not been stringent enough to make these venues materially different from other dark venues.

Both structures have been used by several European brokers for matching client order flow and internally generated orders with more discretion and less regulatory burden than the MTF or RM frameworks.


The revised Markets in Financial Instruments Directive is far-reaching. It will affect all trading venues, all market participants and all asset classes. In this paper, we focus on the impact on equities.

One of the most fundamental changes will be the disappearance of broker crossing networks. As stated in the new regulation, "shares admitted to trading on a regulated market or traded on a trading venue shall take place on a regulated market, MTF or systematic internaliser" (Directive 2014/65/EU, art 25, para 4a). This leaves several large European brokers looking for a new way to match client order flow. Systematic internalisers will still be allowed, but the requirements will become more onerous. The quoting obligations have been clarified, and quantitative definitions based on trading volumes have been added.

Figure 01: Growth of dark MTF market share in Europe (Bats, 2016)

Figure 01: Growth of dark MTF market share in Europe (Bats, 2016)

Regulated markets and MTFs will also undergo significant changes. The application of the reference price waiver will be restricted to trades at the midpoint only. Trading at the bid or offer will no longer be allowed under this waiver.

Another section of MiFID 2 that will affect regulated markets and MTFs introduces restrictions on the amount of dark trading taking place under two of the pre-trade transparency waivers: the reference price waiver and the negotiated trade waiver. Double volume caps, referred to by FCA Director David Lawton as the "clunky aggregate cap mechanism", present an entirely new mechanism for limiting dark trading.

Under MiFID 2, venues operating under the reference price and negotiated trade waivers will be subject to these volume caps:

  • 4% of the volume of trading in a stock in a single dark pool
  • 8% of the volume of trading in a stock across all dark pools

The caps apply only to transactions taking place on a trading venue - an RM or MTF - and not to OTC or SI transactions.

The caps have faced considerable criticism since announcement. Markus Ferber, member of the European Parliament leading work on the overhaul of MiFID 1, noted at TradeTech 2015: "My personal conviction is that the double volume cap will not function." In addition to this, there are concerns that the specifics of the calculation used to activate the caps will cause some unusual trading patterns and will lead to widespread bans on dark trading in many major stocks.

As clarified in the regulatory technical standards, calculation of the caps will be taken from data gathered since January 2017 and will be performed on an individual stock level over a twelve-month rolling window. If the relevant cap is breached, the implication is punitive and binary: execution of that stock in the pool or all dark pools would be prohibited for six months. Due to the difference between the rolling calculation window and the suspension period some stocks could be banned for two consecutive six-month periods.

How prevalent will such breaches be? Several studies have indicated that current levels of dark trading would have a significant number, if not the majority, of stocks breaching at least one of the caps. Research conducted by the London Stock Exchange in November 2015 found that at prevailing levels of dark trading all stocks composing the FTSE 100 Index would exceed the 8% threshold and up to 80% of stocks in other major European indices would exceed the threshold. There are limited incentives for individual venues to curtail dark trading to avoid a breach, so all signs indicate these caps are not a purely academic deterrent - they will be breached by a significant number of stocks.

In Figure 02 we consider the scenario of a stock trading in dark pools at an average of 20% in 2017. The ability to make use of non-displayed liquidity is crucial to reducing implicit execution costs. We expect investors to look at other ways of trading in the dark that will not contribute to or be affected by the caps. We now examine the most significant cap, the large-in-scale waiver.


Block trading refers to the execution of trades that are significantly larger than those that occur on pre-trade transparent venues such as exchanges. ESMA has acknowledged the benefit to investors of being able to trade large quantities of stock without the associated impact of the market. Since MiFID, ESMA has assigned block trading a specific waiver, the large-in-scale waiver.

RPW and NTW value traded as percent of market total Number of FTSE 100 securities in percent band
0-8 0
8-10 0
10-15 19
15-20 43
20-25 27
>25 12
Total 101

Table 01: Impact of double volume caps on FTSE 100 stocks (LSE, 2015)

Electronic block trading has grown significantly in recent years as investors have adopted a range of block trading tools, including desktop conditional order systems such as ITG's POSIT Alert and block trading algorithms such as ITG's POSIT Marketplace and Dark Allocator (see Figure 03). A 2015 study by Alistair Cree and Colleen Ruane confirmed that use of LIS liquidity varied significantly among algo strategies (Cree and Ruane, 2015).

While some of these platforms have operated under the soon-to-be-restricted reference price waiver, their block nature should allow the use of MiFID 2's large-in-scale waiver with minimal changes. This move would grant them exemption from both the calculation of the caps and any subsequent suspension of dark trading.

Figure 02: Dark cap suspension simulation (stock trades at an average of 20% in dark pools throughout 2017)

Figure 02: Dark cap suspension simulation (stock trades at an average of 20% in dark pools throughout 2017)

To qualify for exemption under the LIS waiver, orders in these systems will need to be above the size as defined by ESMA. This stock-specific threshold depends on the security's average daily turnover (ADT). LIS threshold definitions were put under increased scrutiny when industry participants became aware of their increasing relevance. Following an industry consultation in December 2014 ESMA created an additional class of illiquid securities in its LIS definitions (Table 03). In addition to waiver changes for existing platforms, numerous other initiatives have recently sprung up to provide alternatives to trading under the reference price and negotiated trade waivers. These are summarised in Table 02.

Initiative Turquoise Plato Block DiscoveryTM
What is it? Initially launched in October 2014 as Turquoise Block DiscoveryTM and renamed following a cooperation agreement with the Plato Partnership finalised in September 2016, Turquoise Plato Block DiscoveryTM offers a conditional order service designed to facilitate trading of larger blocks than traditional dark pools.
Who is doing it? Turquoise, the equity trading venue that is majority-owned by the London Stock Exchange, in cooperation with the Plato Partnership, a not-for-profit industry group comprising asset managers and broker dealers
How does it work? The service sits on top of the Turquoise Plato UncrossTM offering, and matches standing block liquidity and conditional orders at randomised intervals.
Why will it be exempt from the caps? Though currently operating under the reference price waiver, Turquoise Plato Block DiscoveryTM is designed to support block executions and so is expected to transition to using the large-in-scale waiver to qualify for exemption. Orders participating in the service are already subject to a minimum order threshold, expressed as a % of LIS.
How has the industry responded? Significant buy-side interest helped gather the support of the sell side, with several brokers including ITG interacting with the service from day one. As of November 2016, 23 sell-side firms are offering access to the service through either block indications (conditional orders) or block discovery notifications (firm orders explicitly opting in to interact with the service). Several of these have integrated the service into their algorithms, with the ability to enable this on a client-by-client basis.
Initiative Bats Europe periodic auctions
What is it? A periodic auction book, launched in October 2015.
Who is doing it? Bats Europe, the largest stock exchange operator in Europe
How does it work? A lit order book operating in parallel to the continuous order book, holding very short regular auctions with prices collared by the EBBO. The frequency of the auctions is between 100 milliseconds and five minutes, depending on the liquidity of the stock. Because of the extremely short duration of the call period, randomised end time, and lack of indication at the start of an auction, the potential for pre-trade information leakage is limited. Minimum order size allowed is currently 3000 EUR. Allocation is done on a price-size-time basis.
Why will it be exempt from the caps? The indicative price and size of each auction is published, so the mechanism is considered pre-trade transparent and thus the caps do not apply.
How has the industry responded? As of early November 2016, there are 12 brokers participating regularly in the Periodic Auctions book. Four more are expected to go live later in the month. On 21 October Bats introduced a new Minimum Acceptable Quantity (MAQ) feature, a welcome addition bringing the available functionality more in line with traditional dark pools. Bats had a record month in October with more than 389 million EUR traded in the Periodic Auctions book, up from 305 million EUR reported in September, and a record day with 43 million EUR traded on 5 October.
Initiative Bats LIS
What is it? An indication of interest (IOI) negotiation and execution platform for large-in-scale trades, announced in August 2016.
Who is doing it? Bats Europe, the largest stock exchange operator in Europe, together with BIDS Trading, operator of an existing broker-sponsored block trading network in the US
How does it work? Participants submit IOIs to the Bats LIS system to identify potential matches. When a match is identified both parties choose a designated broker for clearing, and the trade takes place on-exchange. Buy-side participants can control IOIs through their EMS or OMS.
Why will it be exempt from the caps? Order size will be restricted to a minimum of LIS, making trades eligible for exemption under the LIS waiver.
How has the industry responded? Bats Europe is targeting a phased go-live starting at the end of 2016, subject to regulatory approval. BIDS's success in the American market has shown the viability of the model, however it is unclear how much drive there will be for a broker-sponsored trading model within European market structure and regulation, especially in the context of unbundling.
Initiative LIS on SETS order book
What is it? Hidden orders within the LSE SETS lit order book.
Who is doing it? London Stock Exchange Group
How does it work? Block orders can be sent to the LSE's lit order book but will remain concealed from other participants provided they meet the LIS thresholds. The orders can have a limit applied, or be pegged to the midpoint of the best bid and offer. In a sense, this offering could be viewed as a dark order book sitting within the main LSE lit market order book, therefore interacting with both dark and lit contra liquidity. In addition to resting orders, midpoint IOC orders and aggressive IOC orders can also interact with this order type.
Why will it be exempt from the caps? Orders must be large-in-scale to be posted to the book, and so can become exempt under the LIS waiver.
How has the industry responded? There is no information available on the number of members using the service. The total value traded in the first four months of 2016 was just under 200 million GBP.
Initiative Deutsche Börse volume discovery orders
What is it? An enhanced iceberg order type to allow execution of large orders within the Xetra book, launched in December 2015.
Who is doing it? Deutsche Börse, the operator of Xetra
How does it work? The new volume discovery order allows the hidden part of an iceberg order to be executed (matched) against other volume discovery orders (VDOs) at the midpoint of the bid-ask spread in the order book through a second limit. An optional minimum executable quantity ensures that only large orders will qualify for matching.
Why will it be exempt from the caps? Midpoint executions from volume discovery orders benefit from exemption under the LIS waiver. Executions at the bid or offer due to normal iceberg behaviour continue to take place under the order management facility waiver.
How has the industry responded? It is not clear how many brokers are connected to the service. Deutsche Börse has provided exchange members with an incentive to use the service-no trading fees for VDO executions for the first year.
Initiative Euronext hidden orders and iceberg enhancements
What is it? A new service allowing market participants to execute large-in-scale hidden orders and enhanced iceberg orders on Euronext's central order book, announced in June 2016.
Who is doing it? Euronext, operator of the primary stock exchanges in Amsterdam, Brussels, Lisbon and Paris
How does it work? Market participants will have the option to specify a second limit on their iceberg orders for crossing at mid, as well as to randomise their display sizes to avoid detection. In addition, the central order book will support completely hidden orders at multiple price levels.
Why will it be exempt from the caps? Both hidden orders and enhanced iceberg orders will benefit from exemption under the LIS waiver.
How has the industry responded? As of November 2016 regulatory approval is still pending. When the service goes live, currently planned for early 2017, member firms will have access through their existing connectivity to Euronext.

Table 03: Market initiatives in response to to MiFID 2 dark trading rules

All of these initiatives are examples of welcome innovation in the dark trading space in response to coming regulatory changes, giving investors new tools to find liquidity when the old ones become constrained or outlawed. Meanwhile, the old tools are still serving the industry's needs, so many of these initiatives have seen limited uptake thus far.

Figure 03: Three-month moving average of monthly trading volume across European block trading platforms: POSIT Alert, Turquoise Block Discovery, Liquidnet, normalised to 100.

Figure 03: Three-month moving average of monthly trading volume across European block trading platforms: POSIT Alert, Turquoise Block Discovery, Liquidnet, normalised to 100.

The initiative with arguably the highest level of backing from both sides of the industry, Turquoise Plato Block Discovery, recently celebrated a record day with 125.8 million EUR traded on 19 October 2016. This is the result of consistent growth, and the service is well on its way to becoming a significant source of liquidity in the new regulatory environment.


On 23 June 2016 citizens of the United Kingdom voted 52% to 48% to leave the European Union, creating uncertainty around the future of the UK's place in Europe. While the exact outcome of a potential Brexit is not known, and setting aside the possibility of a second referendum, one likely model would result in the UK's adopting the full set of rules imposed on other EU firms in MiFID 2.

Regardless of the regulatory model adopted post-Brexit, the UK has an extensive negotiation process ahead to finalise a withdrawal agreement with the remaining 27 member states of the EU. The negotiation period allowed under the Lisbon Treaty extends to two years from the invocation of Article 50, which is likely to happen in the first quarter of 2017. This leaves January 2019 as the earliest date for the UK to leave the EU, more than one year after MiFID 2 takes effect. We therefore fully expect the regulatory changes discussed in this paper to apply to the UK as they will to other current EU member states.

Average daily turnover (EUR) Minimum size of orders qualifying as large-in-scale compared with normal market size (EUR)
ADT < 50,000 15,000
50,000 < ADT < 100,000 30,000
100,000 < ADT < 500,000 60,000
500,000 < ADT < 1,000,000 100,000
1,000,000 < ADT < 5,000,000 200,000
5,000,000 < ADT < 25,000,000 300,000
25,000,000 < ADT < 50,000,000 400,000
50,000,000 < ADT < 100,000,000 500,000
ADT > 100,000,000 650,000

Table 02: Large-in-scale threshold definitions (ESMA, 2015)


Dark trading in Europe has grown significantly in recent years, with increasing adoption by investors looking to minimise market impact on large orders. A variety of tools, from broker algorithms to blotter-sweeping desktop applications, have become indispensable components of the modern liquidity-seeking trader's workflow. Brokers, exchanges and other technology providers have invested in building algorithms, desktop tools, MTFs, SIs and BCNs, and to some extent have all become a part of the European dark marketplace.

MiFID 2 will impose a significant limitation on many of these aspects of dark trading. The disappearance of BCNs, restriction of the reference price waiver to midpoint, and introduction of double volume caps will all change the dark trading landscape in their own ways. In the inevitable event of a suspension of dark pool trading triggered by the volume caps, investors will be restricted to a few specific ways of finding liquidity in the dark, most notably the use of large-in-scale orders.

The possibility and reality of these restrictions will force investors to access dark liquidity in a more deliberate way, and the industry is well on its way to providing the tools to allow investors to do this. The continued availability of current market structure solutions has limited the need for these new tools, but this is expected to change as soon as the new regulation comes in.


  • LSE 2015 "Transparency for equity instruments", Presentation at LSE "Market Insights" event on 26 November 2015.
  • Bats 2016
  • ESMA 2015 MiFID 2 final report - draft RTS (ESMA/2015/1464)
  • Cree A. and Ruane C. 2015 MiFID 2: Impact of dark caps on algorithmic trading strategies.