Dark Pool Warning Sounded by ECB as Europe Weighs New Rules

(Bloomberg) — New regulations designed to make trading more transparent may have the opposite effect by encouraging the emergence of so-calleddarkpools in fixed-income markets, the European Central Bank said.

In a report on financial stability Wednesday, the ECB called for more study of the development and potential effects ofdarkpools and for closer monitoring of the evolution of fixed-income markets.

Bonds are more heterogeneous than equities and traded less frequently but in larger trade sizes, the report said. Thus fixed-income traders may preferdarkpools to avoid revealing intent and trading with more informed counter-parties.

Asset managers in recent years have turned to electronic platforms to buy and sell large blocks of bonds anonymously. Thats partly because banks have pulled back from the business of wholesaling debt because of rising regulatory costs. Credit Suisse Group AG shook Europes bond markets last month with its decision to drop its role as a primary dealer for government bonds.

Opaque trading venues for European stocks surged after the European Union overhauled its rules in 2007 to break the exchanges monopoly over share trading. The EU is now expanding the rules, part of a broader regulatory package known as MiFID II, to include fixed-income trading and to rein in the use ofdarkpools for equities trading.

Darkpools serve investors wishing to avoid the market impact costs of big-ticket trades. As the price and volume are not disclosed before the trade, investors can place an order without showing their hand to traders. Europe is imposing limits on such venues for stocks out of concern that they are making prices on public exchanges less accurate and that fragmentation could make markets less liquid.

The new regulation aims to bring more trading to transparent venues, which, if successful, would also result in more liquidity on those venues, the ECB said in the twice- yearly report.

While the majority of traders would benefit from them, some market participants might become more reluctant to engage in the market, as they may perceive transparency to increase the risks and costs of trading, the ECB said.Darkpools for fixed-income instruments may emerge, pooling together liquidity and further changing the structure of these markets.

Daily trade on a type ofdark poolknown asdarkorder books has increased from less than 1 percent in 2010 to more than 8 percent of all trading in equities reported by the largest exchanges, the ECB said. These registered venues use pre-trade transparency waivers and external reference prices.