The changing status of dark pools in the European equities landscape

Dark venues have been a significant part of the European equities market for almost 15 years. Throughout this time, they have met the needs of institutional investors looking to trade large volumes discreetly. They have frequently been the target of regulators, seeking to improve market transparency, and level the playing field for individual investors. However, regulatory pressures cannot remove the basic requirements that dark venues fulfill, and attempts to consolidate volume in lit markets have largely been unsuccessful. Now, with the impact of MiFID II becoming clearer, UK regulators seeking their own path, and fresh players entering the space, the future of dark venues remains unclear to many. Traders seeking access to dark liquidity need to adopt flexible strategies that can meet the challenges of this ever-changing environment.

The development of dark trading in Europe

There is a wide range of different dark venues, but they all share key features. Dark pools are private and only accessible to members, generally large institutional investors. They do not display market depth data, meaning that the total amount of liquidity in the market remains invisible to all. All orders are effectively private until they are executed, visible only to the owner and the venue itself. This makes dark venues ideally suited to counterparties seeking to trade large volumes without affecting the wider market (specialist block traders, for example).

Dark pool trading originated in the United States in the 1980s, arising from regulatory changes and technological development. In Europe, dark venues only started to capture a significant share of equity trading in the late-2000s. The first Markets in Financial Instruments Directive (MiFID), implemented in 2007, standardized transparency requirements across EU venues. However, it also allowed market participants to waive these requirements in certain circumstances, if price requirements were met. Major investors, concerned that mandatory pre-trade disclosures would allow their competitors too much insight into their trading strategies, increasingly took advantage of these waivers to trade in the dark. Between 2009 and 2016, the share of European equity volume traded on dark pools increased from less than 1% to over 8% of total value.

The growing importance of dark trading to the European equities landscape prompted a further regulatory response. The MiFID II directive (implemented in 2018) attempted to address concerns that the growth in dark trading was harming price discovery and excluding smaller investors. The Double Volume Cap (DVC) restricted the permitted level of dark volume that could be traded per-instrument to 4% per-venue, and 8% across all EU venues. Some concessions were made to address the concerns of market participants – for example, the Large in Scale (LIS) waiver allowed large block trades to avoid pre-trade reporting. However, the general goal of the regulation was to restrict dark venue trading as far as possible.

Initially, at least, MiFID II dramatically impacted dark trading. By the end of May 2018, dark pool volumes had shrunk to around 0.15% of the European equities markets. However, there was no corresponding growth in lit markets. Instead, alternative methods of trading while revealing minimal price information began to proliferate. Several venues began to offer periodic auctions throughout the day, allowing participants to access liquidity without appearing on the lit order book. Increasing volumes of buy-side flow moved to new broker-run Systematic Internalisers (SIs). Volumes in over-the-counter trading also increased throughout this period. The regulator’s goal of boosting the mainstream lit markets remained elusive, and by mid-2019, dark volume had returned to pre-MiFID II levels.

The current landscape, post-MiFID and Brexit

The impact of MiFID II has left the European equities landscape fragmented. Rather than consolidating in conventional lit markets, liquidity is increasingly spread across OTC, auction, and dark venues. The entry of new players into the space illustrates the continuing relevance of dark pools. In March 2022, Aquis confirmed their purchase of UBS’s MTF business. In announcing the deal, Aquis confirmed that they believed dark trading would likely remain an important part of the European equities market, regardless of regulatory changes. They also stated that they saw the acquisition as complementing their existing offering of lit venues. It seems many venue operators continue to regard dark pools as an asset, rather than a threat, to the market as a whole.

The regulatory environment continues to develop. Post-Brexit, the UK Financial Conduct Authority (FCA) has suggested it will take a more liberal approach to dark venues. Over the last two years, the FCA has taken several steps to encourage dark trading, including:

• Lowering the LIS threshold, above which dark trading can take place.
• Announcing it would not apply DVC restrictions in the equities market.

The UK Treasury endorsed this approach when it announced the results of its Wholesale Markets Review earlier this year. This confirmed that the DVC would be abolished entirely, once Parliamentary time allows.

Whether in response to the UK’s attitude, or simply as an acknowledgment that the MiFID II regulations have not had the intended effect, EU regulators have also begun to change their approach to dark trading. In November 2021, the European Commission published proposals to reduce the market-wide volume cap from 8% to 7% while removing the 4% venue-specific cap – in effect creating a ‘Single Volume Cap’. They may even go further. Clearly, regulators on both sides of the channel remain focused on dark pools. Further regulatory change (and perhaps increasing divergence) can be expected.

Searching for liquidity across markets

Having survived these recent regulatory pressures, dark venues seem likely to retain their place in an increasingly fragmented European equities space. For counterparties trading large amounts of volume, this fragmentation makes a flexible approach to execution more important than ever. Access to a wide range of venues remains essential, but traders must also have the tools necessary to integrate these separate pools of liquidity into coherent strategies.

Creating strategies in Fidessa Spotlight

For over 10 years, the Fidessa Spotlight and Premium Spotlight tools have helped our customers to access dark liquidity through multi-venue trading strategies. Now ION is launching the new generation of the Fidessa Spotlight solution, designed to help traders meet the challenges of the fragmented equities markets. It incorporates a range of new features, including:

• The ability to build sophisticated, multi-phase strategies, targeting lit, dark, and conditional venues.
• An improved user interface, allowing you to visualize your strategies as you build them.
• Customization options at every level, allowing you to add venue- and client-specific logic to your strategies.
• Seamless integration with the Fidessa ADSA and Block Shadow algorithms, allowing you to incorporate these algos into your wider trading strategies.