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March 1, 2011

ITG to EC: Don't Limit Order Size

By Chris Kentouris

The European Commission should not limit the size of orders executed in dark pools when Europe revises legislation on best execution, concluded brokerage firm ITG in a recent report entitled, "ATSs in Europe: Post-MiFID performance."

The study authors, Ian Domowitz, a managing director for ITG's networking and analytical research products, and Yossi Brandes, a director responsible for ITG's European research and business development, say that trading in dark pools has not harmed liquidity in lit markets; it has actually helped.

The study analyzed nine dark pools, four lit MTFs and exchanges over the first 10 months of 2010, It found that trading in dark pools was 13 percent less expensive than on regulated exchanges and 18 percent cheaper than in lit MTFs.

"By imposing size restrictions, retail investors may not be able to utilize MTFs that provide them best execution and institutional investors would be unable to reap the full benefits of breaking up parent orders to achieve better prices," says ITG. "We do not believe that the increased usage of dark pools impedes market quality and we have postulated that it may actually improve market efficiency."

In its study, ITG did not identify the venues it measured. Among the best-known dark pools are NYSE Euronext-owned SmartPool and Chi-X Europe's Chi-Delta. Although the estimated two dozen dark pools in Europe account for only four percent of trading, they have generated plenty of debate--and concern. In its request for comments in late 2010 on changing MiFiD, the EC said that the increased use of dark pools could affect price discovery and should be studied by regulators

ITG included its findings in a letter to the EC which wants industry input on how it should revamp the Markets in Financial Instruments Directive (MiFID). The legislation passed by member states of the European Union in late 2007 requires financial firms to ensure they have received the best deal for their clients in executing orders. Its adoption has created plenty of competition for traditional exchanges by creating a cottage industry of so-called alternative trading platforms, including dark pools. The EC is expected to publish plans for its proposed MiFID overhaul shortly, with dark pools and high frequency trading high on its agenda.

(This story originally appeared in Securities Technology Monitor)


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