The volume caps on trading in dark pools will lead to more innovations around auctions to help investors trade large blocks but could also lead to increased costs.

Trading in large size is likely to become more difficult when the MiFID II regulations, covering financial markets in the European Union from 2018, place caps on volumes of dark pool trading of 4% in any one stock on any dark venue and 8% of total volume across European dark venues.

Philippe Guillot, executive director, markets directorate, Autorité des marchés financiers (AMF) said at the FIX EMEA Trading Conference last week the aim of the caps was to bring liquidity back to lit venues where prices are formed. The French regulator added that the rise of exchange-traded funds and passive fund management had also contributed to concerns about price formation.

Natan Tiefenbrun, managing director, European execution services and co-head of agency equities trading at Bank of America Merrill Lynch argued at the FIX conference that there was no evidence that price formation in liquid securities was under strain in lit venues and the caps will lead to more expensive trading for investors.

“MiFID II is consolidating liquidity in a highly unhelpful manner,” Tiefenbrun added. “It significantly raises the barrier to the entry and will lead to fewer asset managers and brokers, which will have a negative effect on the industry.”

Tiefenbrun continued that if brokers cannot cross internal flows under MiFID II, without registering as a systematic internaliser, this will lead to higher spreads as investors will have to pay fees to an external venue. “Lit venues have different characteristics and there is also information leakage,” he added.

James Hilton, co-head of advanced execution sales at Credit Suisse Securities (Europe), said a large number of stocks will hit the MiFID II volume caps.

“We always look for block trading opportunities but there are not enough out there,” Hilton added. “We will see more focus on auction type models and initiatives such as Turquoise Block Discovery.”

In 2014 Turquoise, the London Stock Exchange’s pan-European multilateral trading facility, launched Block Discovery which was designed to bring together large block orders in random intra-day auctions. The London Stock Exchange has also announced plans to offer a new auction at noon, matching the intraday auction in Germany.

Last October Bats Europe launched a periodic auction throughout the day to help trade in larger sizes. Auctions last a randomized time of between 100 milliseconds and five minutes, depending on liquidity of the individual stock. Matches are only allowed within the European Best Bid and Offer and a new auction begins as soon as one ends so a stock is always in auction. Trading in the periodic auction is in a lit book and subject to pre-trade and post-trade transparency, so the MiFID II dark volume caps do not apply.

Tiefenbrun added that Bank of America Merrill Lynch had not yet connected to the Bats Europe periodic auction but the product holds some promise.

Anish Puaar, European market structure analyst at Rosenblatt Securities said in an interview in the latest World Federation of Exchanges magazine that last year the share of dark pool trading fell, for the first time, to 5.72% of overall EU turnover (including OTC trading) from 6.46% as volatility increased.

Puaar said that under the MiFID II rules existing dark venues are likely to launch services geared towards larger trades or those that require some pre-trade transparency, to avoid being hit by the volume caps. “Investment banks are likely to launch dark MTFs and/or systematic internalisers to replace broker crossing networks but need to be wary of excessive fragmentation that could make the hunt for dark liquidity difficult,” he added.

Guillot said the next step for MiFID II is for the Regulatory Technical Standards and Delegated Acts to be issued in the coming weeks. He continued that the final rules are likely to be mostly implemented under a Q&A system, which offer the most flexibility.

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