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Sound Bytes: Dark pools, liquidity and emerging markets

First Published 23rd April 2014

Upcoming change to dark pools in the new regulatory regime was a key issue at the recent Trade Tech conference in Paris. In this edition of 'Sound Bytes', Automated Trader hears what industry figures and one regulator from the UK's Financial Conduct Authority have to say.

Paris - Upcoming change to dark pools in the new regulatory regime was a key issue at the recent Trade Tech conference in Paris. In this latest edition of 'Sound Bytes', Automated Trader hears what industry figures and one regulator from the UK's Financial Conduct Authority had to say.

We also hear about views on trends in gaining access to liquidity and the popularity of emerging markets for the algorithmic trading community.

Sound Bytes lets you cut through the clutter to hear exactly what's on people's minds. The comments came from panel discussons and interviews by Automated Trader.

Tim Rowe, Manager, Trading Platforms & Settlement Policy, Financial Conduct Authority (panel discussion)

In terms of the dark space, in cash equity ... I think a key thing that stands out for everyone when I have this conversation is the 4% and 8% caps, which will be introduced on the amount of usage of the waivers. Of course one of the things that has sometimes got a little bit lost in the discussion about this is that the 4% and 8% caps ... don't apply to all dark trading. It's actually about, effectively, one and a half usages of the four waivers. So very briefly, the four waivers are: reference price waiver, where you trade on a system which derives its prices from another venue, the negotiating trade waiver, where you do a trade on an off-book basis, report it to a venue at or within the spread or because that trade is subject to conditions other than current market prices...; there's the order management facility waiver which is all about sending orders to a venue and those orders remain dark for some reason, it might be something like Iceberg functionality; and then there's the large-in-scale waiver. Of those waivers, it's only actually the first, reference price waiver, and half of the negotiated trade waiver... which are actually subject to the cap. All the other stuff, so for instance large-in-scale, is not subject to the cap, which is important because when you look at the 4% and 8% caps, they look pretty darn low... Of course you still have the ability to trade OTC to an extent, but there will of course be now on ongoing trading obligation to help draw OTC cash equity onto, supposedly, the lit venues. So that's very much fixed. We've got those 4% and 8% caps, we know what they relate to.

How the actual mechanics will work of course is completely different. How will we make sure we've got the right data to be able to judge where instruments sit vis a vis those limits? How will the industry go about managing trading versus those limits and how should that be organised? Those are all questions to be answered in due course. And quite aside from that, with respect to the large in scale waiver, they might not be subject, those trades, to the caps. But where the large-in-scale threshold sits for any given instrument is an open question and that's something that ESMA will be consulting on in due course. Should the thresholds go up, down or stay the same? So, there's a mixed bag at the moment in terms of what is currently fixed by virtue of the Level 1 legislation that was agreed a couple of months ago, and what is still in a state of flux. And an awful lot of this will be explored in the next couple of months as ESMA starts to produce consultation documents.

Brian Schwieger, head of equities, London Stock Exchange Group (panel discussion)

I think the issue that the industry has is that, if we look at dark pools today, most of them are operating under the reference price waiver. Most of the executions that we see going on in the dark would come under the reference price waiver. So the challenge for the industry is now, what can we do with that flow, do we simply put it on to the lit venues or can we find other ways of trading that which would be within the new cap regime?

Some of the ideas which have come from the industry... intraday auctions, that's obviously something which the LSE is currently consulting on. New order types, for example, conditional orders: so this is the idea whereby a tentative order is placed in a dark pool and where another order comes, which could potentially match with it, they're firmed up and brought together; the advantage of the conditional order type is that it allows for larger execution to take place, thereby hopefully increasing the number of large-in-scale executions that the dark pools might be able to have. Other execution types again will be things such as systematic internalisers. And I think really the solution for this is not going to come from the market venues themselves but actually from the brokers, and potentially also from the buy-side in terms of putting together algorithms which are actually able to use all of these various tools and come up with solutions for the investor.

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