Dark pool stock trading picks up as Europe debates new curbs


* Dark pool trading on the rise

* Throws fresh focus on MiFID 2 talks

* Lack of data makes regulation hard to design

* Australia experience a potential guide

By Sinead Cruise and Simon Jessop

LONDON, Oct 15 (Reuters) - Fund managers are trading moreassets on private exchanges known as dark pools, a growing trendthat clashes with regulators' mission to improve financialmarket transparency.

Dark pools are electronic trading networks that allowinvestors to buy and sell stocks anonymously, in private dealsso other shareholders are not aware of the trades. Some of thedetails are made public but only after the market has closed.

That contrasts with public exchanges such as the LondonStock Exchange where large buyers and sellers are required toidentify themselves and stock prices reflect trading activity inreal time, throughout the day.

Some investors are shifting business away from publicexchanges because they feel these offer little chance tonegotiate cheaper bulk buying or to sell without triggeringsell-offs that can cut the price they fetch for their assets.

"If you want to buy one suit or one car, you see one price.If you want to buy 100 suits or 100 cars, you approach theseller to discuss another price. Who benefits from that? The endinvestors," Vincent Dessard, regulatory policy advisor at theEuropean Fund and Asset Management Association trade body, said.

Thomson Reuters and Markit data suggests the volume of darktrading rose for the fifth consecutive month in September,accounting for 5.84 percent of all European share trade, morethan double the 2.8 percent volume recorded in September 2011.

The rising popularity of off-exchange activity has sparkedfresh debate over proposed caps on dark pool trading in the nextrevision of the European Union's (EU) Markets in FinancialInstruments Directive (MiFID), under discussion in Brussels.

Policymakers want to cap daily dark trading at 4 percent oftotal trading in each stock in the EU, and total aggregated darkpool transactions at 8 percent of all European trade.

They worry that transactions capable of destabilisingmarkets could go undetected unless limits are introduced. Theyalso fear users are draining liquidity from public exchanges,making it harder for other investors to value stocks accurately.

Anyone can use these pools if they have membership and feesare typically lower than trading stocks using traditionalstockbrokers. The biggest users of these networks are large fundmanagers and banks who regularly trade large volumes of stocks.

Supporters of off-exchange trading say removing the optionof buying and selling shares privately will make largeportfolios more costly to manage and potentially hurtperformance of investment funds and pensions.

"This will hurt liquidity but more specifically, it willhurt European citizens. When the price for one security is set,you are removing the capacity for an asset manager to negotiatesomething lower," Dessard added.

Thomson Reuters aggregates all trade data on 'dark'Multilateral Trading Facilities (MTFs) and platforms provided byBATS-Chi X, London Stock Exchange-operated Turquoise andLiquidnet.

MTFs match buyers and sellers anonymously and publish thetrade on data feeds available to all market users after themarket has closed.

The Markit data, meanwhile, only gives a snapshot ofaggregate trade at six of the large Broker Crossing Systems,where bank traders match up clients privately but only reportthe trades in a job lot at the close, without breaking down thestocks concerned.

Without more comprehensive data, critics say it is tough toestablish whether dark pools help or hinder the broader market,or make public exchanges less efficient in discovering price.This could render new rules challenging to enforce.

"Because the data isn't really out there to understandprecisely what is the percentage of market share of dark pools... It's very hard to know if we're at that cap or beyond it,"Mark Goodman, head of quantitative electronic services, Europeat Societe Generale, said.

Echoing this, Mark Hemsley, CEO of BATS Chi-X Europe, said:"There is logically a point where moving flow into the dark isdetrimental to the price-formation process but I have yet to seea study of the European market that says what that number is."

This lack of clarity in the UK contrasts sharply with Canadaand Australia, where more data is available, allowing academicsto research what constitutes 'good' or 'bad' dark trading.

In Asia and the United States, the volumes of shares tradedusing dark pools is even harder to track, analysts say, mainlybecause bank traders and other dark pool providers are notsubject to the same strict post-trade reporting rules asEuropean peers.

Professor Carole Comerton-Forde from the University ofMelbourne published research in July entitled 'Dark trading andprice discovery' and found only high levels of specific types ofdark trading were damaging to Australia's stock market. She isconfident the results would be similar in Europe.

When a pension fund or investor wants to sell a large numberof shares also known as a 'block' trade, dark trading was"absolutely essential", she said, and could be done in unlimitedquantities without hurting the broader market.

Only the migration of large volumes of smaller trades to thedark pools was more "problematic", Comerton-Forde said, as theytraditionally accounted for much of the liquidity on exchanges.

"When the trade's done in the dark, it means we're notseeing that order flow on the exchange and observing order flowis very helpful in terms of understanding prices," she said.

When dark trading reached 25 percent of all trading inAustralia, local regulators decided to act, forcing anyone whowanted to trade in the dark to beat the on-exchange price.

The volume of dark trades below block size have now droppedby half to around 5 percent of total market activity, she said.


Market participants say demand from big investors to tradelarge volumes of shares away from the public stock exchangeswill remain even if MiFID 2, goes through as proposed.

"Assuming everyone will stop trading in the dark andautomatically go to trading on lit exchanges is just fantasy,"said Rebecca Healey, senior analyst at consultant TABB Group,adding that much of that trade had never been on-exchange.

"The traditional exchanges are very worried about the amountof dark activity that is happening but the irony is that that'snot necessarily trading they would have interacted with before."

The fledgling European economic recovery is temptinginvestors back into European equities, a Reuters Poll shows, but market volumes remain depressed after yearsof turgid activity during the debt crisis, forcing fund managersto consider all options in their quest for liquidity.

For Derek Mitchell, senior equities fund manager at RoyalLondon Asset Management, the trading opportunities provided bydark pools are difficult to match elsewhere.

"Our old dealer has just retired and we've just recruitedsomeone ... who has much greater experience of using dark pools.Since he arrived we've been using them more and benefiting fromhis expertise...The liquidity you can access is hard to ignore."

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