Sunday, December 13, 2015

Under-the-radar exchanges (Dark pools) in Europe prepare to face a potent new challenger.

In the world of Europe’s dark pools, a new player is poised to make a splash. Plato Partnership, a London-based consortium of asset managers and brokerage houses, is about to take on existing trading venues that don’t publish pre-trade price and volume information, including those operated by BATS Chi-X Europe and London Stock Exchange Group’s majority-owned Turquoise platform. The prize: the business of trading large blocks of stock for the biggest institutional investors.

Plato’s entry into the market comes just as the European Union is changing the rules of the game. Trading in the dark has never been as popular in Europe as in the U.S. Only about 9 percent of European equity volume is traded over unlit venues compared with more than 40 percent in the U.S. EU regulators want to keep it that way. They’ve drafted new regulations, which come into effect in January 2017, requiring all EU trading venues to post pre-trade bid and offer prices and trading volumes—except for those dealing with “large in scale” transactions; such trades (the size of which has yet to be precisely defined) will be exempt. That means if dark pools want to keep the lights off and stay in business, they’ll need to grab market share in big equity orders. Trading such big blocks of stock without tipping off other traders was the reason dark pools were first created, beginning in the 1980s. But over time, that original promise got diluted.

The problem with dark pools in existence today is that regulators don’t trust them, says Paul Squires, the head of trading at Axa Investment Managers. And while institutional investors generally regard dark pools as preferable to lit exchanges, Squires says, they worry that the operators have too much incentive to quietly allow high-frequency-trading firms into the pool. In January, UBS paid $14 million to settle a Securities and Exchange Commission complaint that it secretly created an order type for its dark pool that advantaged high-frequency traders over other customers.
In addition, money managers are concerned about conflicts of interest with the brokerages’ proprietary trading desks. “All the brokers and all the venues will say you can control the flow you interact with, you can apply minimum execution sizes or resting periods, but they put the onus on the buy side to do that,” Squires says of existing venues. “The buy side doesn’t have the capacity to do that effectively in such a complicated marketplace.” It’s a point Norges Bank Investment Management, which oversees Norway’s $890 billion sovereign wealth fund, made in research paper published in April. From an asset manager’s perspective, Norges said, there would ideally be only one dark pool.

This explains why Axa and Norges have gotten behind Plato, which is also being backed by Deutsche Asset & Wealth Management, Fidelity Worldwide Investment, Union Investment, J.P. Morgan Asset Management, and a group of sell-side banks, including Citigroup, Goldman Sachs, Barclays, and UBS.

The new EU rules will force dark pools operated by sell-side institutions to restructure, open up to more participants, and comply with new regulations. Rather than do so, most brokerages are shuttering their dark pools and instead joining consortia like Plato and multilateral pools such as Turquoise. “It gives us the opportunity to design something progressive from scratch,” Squires says of Plato. He also likes that Plato—unlike existing dark pools—will be operated as a not-for-profit, with any money left over after expenses committed to academic research into market structure. “That is an important signal to regulators and to clients,” he says.
The advent of Plato has the current crop of dark pools eager to emphasize their own buy-side-friendly features. Robert Barnes, Turquoise’s CEO, says the company has in place a working group of money managers helping to shape its future. And Mark Hemsley, head of European business for BATS Chi-X, which runs Europe’s two largest dark order books by total trading volume, says his firm gives investors the liquidity they need to complete large orders quickly. Still, he’s monitoring Plato. He says a potential problem with block-trading venues like Plato is that they’ll fail to match buyers and sellers, especially at times when the whole market is moving in one direction.

For all the saber rattling, Plato’s relationship with the other dark pools is more “frenemy” than pure foe: The upstart pool is looking for a new company to trade its platform. Among the leading contenders: BATS Chi-X and Turquoise.