The lights are dimming in Europe’s financial markets. Just as it has in the U.S., an increasing amount of Europe’s stock trading is migrating off public exchanges and into private venues known (unfortunately for them) as dark pools, where trades aren’t made public and prices aren’t reported immediately. Reliable data on dark pools can be tough to come by. The biggest one in the U.S., Credit Suisse’s Crossfinder, stopped reporting its data in April. Still, the available evidence points to a recent spike in the amount of trading that’s going off in the dark in Europe.
That’s especially frightening news for exchanges.
According to calculations by Rosenblatt Securities, each day in September, an average of €3.8 billion changed hands across 19 dark pools tracked by the market research firm. That’s about 6.4 percent of the €59 billion traded daily across Europe in September. In 2010, dark-pool activity was closer to 2 percent of Europe’s trading value.
Dark pools account for about 12 percent to 15 percent of trading in the U.S., measured by trading volume, not dollar value. There are roughly 40 dark pools in the U.S. Some of the biggest are run by banks and brokerages: Credit Suisse (CS), Barclays (BCS), Citigroup (C), Deutsche Bank (DB), Goldman Sachs (GS). The same banks operate some of the biggest dark pools in Europe as well.
Measured by volume, Tabb Group, another market research firm, puts Europe’s dark-pool share at 11 percent. In October, a U.K. trading technology company reported that European dark-pool trading was up 45 percent over the previous six months.
“There’s been a significant pickup since June,” says Justin Schack, head of the market structure group at Rosenblatt. Schack says it’s hard to tell exactly what’s driving the recent increase; it could be seasonal, he says, or due to a lack of trading activity by noninstitutional investors. What is clear is that “there’s been a heightened appreciation for the value of dark markets on the part of buy-side firms in Europe,” says Schack. Big institutional investors are becoming more comfortable with using sophisticated trading algorithms that Schack says route orders not just to the primary exchanges but also to a whole host of alternative venues and broker crossing networks.
Dark pools originated as safe havens of sorts, where pension and mutual funds—known as “the buy side”—could trade large amounts of stock anonymously, without being detected by more sophisticated high-frequency trading firms. On public exchanges, the faster HFT firms could often jump in front of large buy-side orders and drive prices up.
Dark pools are fiercely debated in the U.S. Proponents say the bank-owned brokerages that run them save their clients money by not having to pay fees to the exchanges. The exchanges contend that the dark pools have an unfair advantage because they aren’t subject to the same kind of rules the exchanges are. Public exchanges have to file extensive data on trading activity to the Securities and Exchange Commission. Since dark pools are run by brokerages, they can control who trades, granting access only to certain firms and charging them different prices.
As the Financial Times points out, the same debate is heating up in Europe, where lawmakers, banks, and exchanges are fighting over the degree to which dark pools will be allowed to flourish there.
“Some pockets of the exchange community still just aren’t happy about the idea of having competition, full stop,” says Schack. The European Commission is pushing for new caps on dark pool trading that would bar any one dark pool from hosting more than 4 percent of all trading in one stock and limit all dark pool trading to 8 percent of all trading in Europe.
“It’s crucial for politicians and regulators to have clear, hard facts in front of them,” says Rebecca Healey, a senior analyst at Tabb Group in London. “And the facts are that the buy side needs dark pools to execute their orders.”
Healey says the alarm around dark pools is overstated and that the recent increases are largely due to institutional investors returning to the market and choosing to route their orders through dark pools. “The buy side has educated themselves around the benefits of trading in the dark,” says Healey. “But it’s not like dark pools are going to take over the world.”
