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May 1, 2011

No Changes To Dark Pools: Buyside

By James Ramage

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  • No Changes To Dark Pools: Buyside
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The buyside has a message for legislators in Europe: We like the anonymity of trading in dark pools, so don't change the game with new rules that would force us onto public markets.

Dark pools remain a crucial option for the buyside to trade large orders with minimal market impact, institutions have said. And the reforms to the Markets in Financial Instruments Directive-or MiFID II-would threaten that option, if they passed as they're currently proposed. Legislators in Europe will address the proposals this month and could vote on them sometime in the fourth quarter.

Some institutions, such as Boston-based Wellington Management Co., voiced their opposition to new rules for dark pools in comment letters to the European Commission regarding the MiFID review.

"We oppose the unilateral imposition of regulatory burdens on the [broker crossing systems] segment of a firm's trading operations without strong justification," Wellington wrote. "Such actions may serve to drive [broker crossing systems] out of the market landscape and cause more opaque, less regulated venues to gain share."

The comment period ran from Dec. 8 until Feb. 2. The proposals to reform MiFID drew a strong response from industry participants, as more than 4,200 letters poured in during the 56 days.

The original MiFID directive took effect in November 2007 as a means to raise competition across the European Union at exchanges and other trading venues. It permitted new competition from ECN-like execution venues, called multilateral trading facilities-MTFs. Last year, the European Commission proposed a further review, MiFID II.

Among those measures that would affect crossing networks, whether dark pools or broker internalization engines, is a proposal to reclassify broker-dealer dark pools as organized trading facilities. Also, broker-dealer crossing networks that clear a certain volume threshold would be forced to register as MTFs. As a result, they would carry increased regulatory obligations. MiFID II also seeks to bring a degree of transparency to dark pools post-trade and to curb internalization, in general.

The Investment Company Institute, the national association of U.S. investment companies, isn't taking the MiFID II plans for dark pools lightly. ICI felt strongly enough about the matter to comment on this topic-not surprising, given that it represents institutional investors of more than $12 trillion of assets from more than 90 million individual shareholders. ICI data show that, as of September 2010, U.S.-based long-term mutual funds held $2.1 trillion in non-U.S. securities, accounting for almost 25 percent of the assets of these funds.

Dark pools, ICI wrote in its letter to the EC, not only make it cheaper to implement trading ideas, but also lessen the risk of information leakage. And they let funds avoid interactions with market participants who want to profit from the public display of large orders to the detriment of funds and their shareholders.

"The importance of funds being able to trade efficiently in large size cannot be discounted," the ICI wrote to the EC. "The confidentiality of information regarding fund trades is of significant importance to ICI members. Any premature or improper disclosure of this information can lead to front-running of a fund's trades, adversely impacting the price of the stock that the fund is buying or selling."