European regulators face a growing backlash over moves to impose greater transparency on parts of the equities and derivatives markets as the region gears up for reforms mirroring US efforts to make the financial system safer.
The European Commission has proposed sweeping changes to the way the equities and derivatives markets are traded in its review of the Markets in Financial Instruments Directive, implemented in 2007.
That sparked competition in share trading between exchanges and other new types of trading platforms, as well as the use of off-exchange venues and a proliferation of market data.
Regulators have suggested such fragmentation, with multiple ways for data to be reported, has made it hard for investors to compare prices across venues, making Europe’s share markets less transparent.
There are also concerns over the growth of “high-frequency” trading and the use of dark pools and other off-exchange venues.
The Commission has said such issues highlight why transparency needs to be improved in European markets, ranging from equities to over-the-counter derivatives.
It is reviewing Mifid and has proposed measures that would force dark pools to make certain prices public, going back on Mifid’s original allowance that certain types of order be exempt from pre-trade price display in certain circumstances.
However, Liquidnet, the largest operator of dark pools, warned some of the proposals would prevent “tens of millions of European citizens” from benefiting from reduced transaction costs.
One proposal would force asset managers and others making “indications of interest” in a dark pool – signalling an intention to trade – to make public those intentions. Users of dark pools typically use IOIs to show interest in a block trade, then negotiate a match for that trade anonymously in a dark pool to avoid their orders being picked off piecemeal by high-frequency traders.
In a draft letter to the Commission, Liquidnet said: “If we restrict institutions from using systems ... that allow [them] to negotiate and trade blocks directly with other institutions, we are preventing institutions from fulfilling their obligation of best execution to their tens of millions of individual customers in Europe.”
Vlad Khandros, market structure and public policy analyst at Liquidnet, told FT Trading Room: “Transparency at a high level sounds great but when you get to the implementation level it could be disastrous, and that’s when you start having huge unintended consequences.”
Liquidnet also takes issue with a proposal in the review that any portions of a large block order submitted for execution in a dark pool that do not get matched - leaving so-called “stubs” - must be sent to a “lit” market like an exchange or “multilateral trading facility”, where pre-trade prices are revealed publicly.
“Requiring public display of stubs will mean higher trading costs for institutional investors and lower investment returns for [investors],” Liquidnet said.
Industry comments on the Mifid review are due in on Wednesday.
Credit Suisse weighed in on dark pools on Tuesday, telling clients in a note that it was “alarming that so much of the debate is being driven solely by opinion and conjecture”.
Analysts at the bank - which operates a type of dark pool also run by many of its rivals known as a “broker crossing network” - said they had found no evidence that dark pool trading was “damaging to price discovery”.
“Introducing legislation to limit their use risks increasing costs with no discernable benefit to either the market or end-investors,” said the analysts.
Derivatives markets participants are also concerned that the Mifid review proposals, which include how over-the-counter derivatives are to be traded, could damp liquidity by imposing the same type of measures being considered for share markets on unrelated products – like foreign exchanges.
Robin Poynder, head of FX and money markets in Europe at Thomson Reuters, said IOIs were a critical part of the FX forwards market for institutional investors wanting to trade in large sizes.
“We think the G20 reforms are a good thing, and we are all in favour of greater transparency,” he said. “But what we want to avoid is unintended consequences, something that increases the cost to end users like pension funds.”