The European market is preparing for the suspension of trading in dark pools for some stocks from the start of next week, with the largest number of stocks affected being UK names.
In order to encourage trading on lit venues, MiFID II places double volume caps of trading in dark pools of 4% of the total volume over the previous twelve months on a single venue and 8% across all EU trading venues. There are waivers for large-in-scale (LIS) orders and trading in auctions which has led to a boost in volumes of block trades and periodic auctions.
The European Securities and Markets Authority published its calculations on the double volume caps on 7 March, with six-month suspensions going into force on Monday 12 March.
Esma said a statement: “The purpose of the double volume cap mechanism is to limit the amount of trading under certain equity waivers to ensure the use of such waivers does not harm price formation for equity instruments. More specifically, the DVC limits the amount of dark trading under the reference price waiver and the negotiated transaction waiver.”
The calculations had been due to be published in January 2018, but Esma delayed the implementation until this month due to issues over the quality and completeness of the data it had gathered.
Christian Voigt, Fidessa
Christian Voigt, senior regulatory adviser at Fidessa, said in a blog that combining the statistics for January and February leads to a total of 755 securities being capped due to either the 4% or 8% thresholds, including 685 ISINs deemed liquid by Esma.
“Whilst that is just 2.5% of all equities that ESMA lists in its transparency calculations, it represents a whopping 35% of all the liquid instruments listed, where the DVC matters more,” he added.
Duncan Higgins, head of electronic products at ITG said in an email: “Crucially, 85 UK blue chips of 101 stocks in the FTSE 100 will hit the 8% cap. Judging by the information from Esma, German index names appear to be the least affected of all the stocks in Europe.”
He continued that the capped stocks which have the highest amount of trading activity across Europe include UK names such as HSBC, AstraZeneca and Vodafone.
“Implementation of the caps puts live the final set of market changes we prepared for last year,” added Higgs. “When the caps were delayed we pressed ahead anyway.”
ITG changed the minimum threshold for POSIT Alert to large in scale and changed algorithms to prioritise blocks and periodic auction liquidity. He said: “Because of those earlier changes the cap go-live will be less impactful to clients using our trading tools.”
Rebecca Healey, Liquidnet
Rebecca Healey, head of market structure at Liquidnet EMEA, told Markets Media: "The impact of the double volume caps may be less significant than first feared. Less than 5% of the total number of marketwide instruments will be affected, although some of indices such as the FTSE 100 will be harder hit."
Healey noted in a blog that for Germany’s DAX 30, only one instrument will be capped and for France’s CAC 40, six stocks will be affected.
“For UK names the impact is likely to be less significant, given that the FTSE 100 is highly liquid and risk capital is more readily available,” she added. “Although the current proportion of SI activity is skewed towards smaller SI prints, we anticipate a spike in SI activity given the proportion of SI’s registered in the UK versus the rest of Europe, as well as the growing use of synthetic cash crossing.”
Healey continued that Liquidnet trades a significant amount of the FTSE 100 on a daily basis so for clients it will be business as usual. She said: "Venues that do not operate LIS trading or that have a lot of sub-LIS trading will need a significant amount of retuning."
The suspended stocks can still be traded in a dark pool if the size is above the large-in-scale threshold; via a systematic internaliser where risk capital in involved; or on a lit venue, including randomised auctions.
Robert Barnes, chief executive of Turquoise, London Stock Exchange’s MTF, said in an email that Turquoise will continue to accept all orders in all securities which are equal or greater than large in scale under the LIS waiver into the Turquoise Plato order book and Turquoise Plato Block Discovery. However, Turquoise will reject orders that are too small to meet the large in scale threshold, or the capped-out stocks, from 12 March 2018.
“To facilitate trading at the midpoint for sub-LIS orders on securities that are capped out, Turquoise has launched Turquoise Lit Auctions which does not require the reference price waiver to operate and allows investors to trade at the midpoint of the primary market’s best bid and offer,” Barnes added.
He continued that Turquoise recently added minimum execution size functionality to Turquoise Lit Auctions, which adds to the service’s appeal as an execution channel to be incorporated within brokers’ liquidity-seeking smart order routing functionality.
Healey said there will be a continued shift away from pools which operate a below LIS mid-point book. The beneficiaries are likely to be systematic internalisers in UK names, periodic auctions in other European names and large in scale dark pools.
"Market participants have legitimate reasons to use alternatives to if they are seeing sub-optimal performance in lit venues," she added. "So it will take time for volumes to return to lit markets."
Voigt agreed that the announcement of the calculations will further boost the growth in periodic auctions, block trading and systematic internalisers. However he questioned what will happen in six months when the first wave of forced suspensions are lifted.
“Will trading revert to the old ways and the market manage to stay below the thresholds?,” asked Voigt. “Or does this herald a permanent change in market behaviour and a move away from anything related to double volume caps? In which case, you might wonder what the difference is between the double volume cap and a simple ban.”
Alasdair Haynes, founder and chief executive of subscription-based Aquis Exchange told Markets Media: “It is good news that the regulators are not backing down on enforcing their proposals. I commend Esma on acting clearly and decisively.”
Haynes also expects that volumes will spike in periodic auctions and LIS trades while systematic internalisers and certain order types will benefit from the caps.
“There are so many workarounds still available that it will take considerable time to determine the overall impact ,” Haynes added. “Regulators will look very carefully at the outcomes and if they do not see an increase in lit volumes then they will act.”
David Howson, Cboe Europe
David Howson, chief operating officer at Cboe Europe, said in an email the exchange is operationally prepared for the double volume caps to come into effect. The US exchange said in a statement this week that the Cboe Periodic Auctions book had another record month of volume in February. Total notional value traded on the Periodic Auctions book last month was more than €7.1bn, up from €6.5bn in January.
“We believe we are well-positioned for the changing dynamics in the market, which we expect will accelerate when the caps come into effect,” added Howson. “We’re seeing strong growth of our Periodic Auctions book and Cboe LIS, two venues that allow market participants to trade with minimal market impact.”
Esma said it intends to publish the applicable double volume cap data for March on 9 April 2018.
