Navigating Systematic Internalisation

At present BCNs represent an effective way for traders to access dark liquidity in Europe, whether for small or large orders. However, under MiFID II the rules are changing, severely limiting the proportion of dark trading that can be conducted in a dark pool or OTC, unless trading large-in-size. The dark trading caps, which are measured by the volume for a single instrument both across the market and on a venue, is expected to push more trading onto lit markets.

BCNs may register as SIs if they wish to match client flow with their own book or as multilateral trading facilities (MTFs) which cross client order flow (which isn’t permitted on SIs under the revised rules). The discretionary ability of SIs on access, pricing and routing makes them more appealing to the business models of most brokers and more efficient to operate.

They are unconstrained in their tick sizes, unlike registered markets (RMs) and MTFs, and if they offer different fee structures and pricing flows for liquidity provision SIs can potentially build very interesting models for attracting order flow. This innovation could allow an SI to appeal to different types of firms, liquidity providers and takers. Estimates amongst market participants on the number of SIs that will register vary from 50 to 100.

Challenges ahead

However, for the buy-side trader this change may be difficult to manage. Traders will need to connect with RMs, multiple SIs and MTFs before they can fully assess the new trading landscape. They will need to assess the order types, from auctions to rebated liquidity, liquidity and market impact to make an informed decision about best execution. In essence, execution services are being unbundled and may require more buy-side expertise in this space, with the trade-off being increased transparency and greater influence on the direction of their flow.

Connectivity to each of those platforms as a fixed cost would prove to be hard to stomach. Venues will undoubtedly fall by the wayside, merge or potentially become lit venues – depending upon the level of dark trading. Therefore, any fixed cost that is not mutualised may be unpalatable, especially when combined with the on-going operational challenges of managing access to so many additional venues

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