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MiFID 2 double volume caps - the end of dark trading?

Published in Automated Trader Magazine Issue 44 Q3/4 2017

A controversial rule in MiFID 2 is the double volume cap mechanism for dark pools. Recently, a quantitative study presented dramatic numbers on the percentage of stocks that would be suspended under the regime. We investigate if the efficient use of large-in-scale trading can help to mitigate the caps.

Ulrich Nögel

Authors Bio

Ulrich Nögel is co-founder (Analytics) at big xyt, an independent provider of big data analytics. After 15 years consulting experience, with focus on pricing, risk management and clearing of derivatives, he now provides solutions to problems arising from the new regulatory landscape, in particular MiFID 2.

The arrival of the Markets in Financial Instruments Directive 2 (MiFID 2) will fundamentally reshape the European financial markets landscape. The motivation of the European Commission and regulatory bodies was the attempt to bring the benefits of the equities space that were imposed by MiFID to other asset classes and current OTC trading while minimising two negatives aspects: the market fragmentation and the increasing use of dark pool trading with an estimated trading volume of 9% in the EU and 12% in the US (Jaccard, 2016 - see Automated Trader, Issue 40, page 46).

This led to maybe one of the most controversial rules in MiFID 2, the double volume cap (DVC) mechanism for dark pools. With RTS 3 (MiFIR Article 5(9) and 22(4)), MiFID 2 aims to limit dark trading by introducing double volume caps on two of the pre-trade transparency waivers: the Reference Price Waiver (RPW) and the Negotiated Trade Waiver (NTW).

The cap on trading per venue limits the percentage of a single financial instrument that can be carried out on a single trading venue under these waivers to 4%. The cap on dark trading across venues limits the total amount of dark trading of financial instruments across the EU to 8%.

As clarified in the regulatory technical standards (RTS) (ESMA, 2015) the caps will be based on data gathered starting from January 2017 and will be updated on an individual stock basis over a twelve-month rolling window. If the relevant cap is breached, the trading of the respective stock will be suspended from either the respective dark pool or all dark pools, depending on which cap is triggered. The caps only apply to transactions executed on multilateral trading venues (such as RM, MTF, OTF) but not to OTC or SI transactions.

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