Trading on European dark pools reached its highest level since MiFID II went live despite the regulation aiming to shift volumes onto lit exchanges.

Tim Cave, analyst at consultancy Tabb Group, said in a report that trading on European dark pools was 9.1% of all on-exchange activity last month, the highest level since MiFID II came into force in January 2018.

“While the amount of dark trading fell in the early months of MiFID II, it has gradually risen since the first set of caps expired in September 2018, reaching its highest level in April since before the implementation of the new regulatory regime,” he added.

He explained that the biggest factor affecting volumes are the double volume caps for trading in dark pools caps introduced under MiFID II. The caps limit the amount of dark trading in a stock to 4% on any one dark pool and 8% across all dark venues. Volumes are monitored on a retrospective 12-month basis every month, and stocks breaching the caps are banned from trading in the dark for the next six months.

Richard Johnson, principal in the market structure and technology practice at consultancy Greenwich Associates, focusing on equities and financial technology, said in a report that multilateral trading facilities and exchanges are only capturing about one third of buy-side flow under MiFID II.

*New* MiFID II Shapes European Equity Trading https://t.co/Qkk9z5vsvu via @GreenwichAssoc by @_richjohnson pic.twitter.com/S6HkunVNZL

— Greenwich Associates (@GreenwichAssoc) May 7, 2019

“While it is possible that there is some margin of error in this figure, it is nevertheless a sign that regulators’ objective of steering equity trades away from dark and toward lit venues has not succeeded,” added Johnson.

Sourcing Liquidity

The Greenwich survey, MiFID II Shapes European Equity Trading, also found that nearly half, 44%, of buy-side traders find sourcing liquidity harder under MiFID II, while only 16% said it has become easier.

A poll at the FIX Community EMEA conference in March said the regulators should focus on the double volume caps on equity trading in dark pools as the first priority under the mandated review of the operation of MiFID II.

Rebecca Healey, head of EMEA market structure and strategy at Liquidnet, the institutional investor block trading network, said in a report that the responsibility to source liquidity in an evolving market eco-structure increasingly sits with the buy side alongside the obligation to provide best execution to end investors.

She said in the report, What We Learnt At Tradetech: “Unbundling has irrevocably changed the traditional buy and sell-side relationship, with nearly 60% of the audience highlighting the impact of systematic internalisers and electronic liquidity providers as the new providers of liquidity.”

MiFID II required the separation of trading commissions from payments of research. As a result the majority of asset managers have chosen to pay for research out of their own revenues.

Periodic Auctions

Cave added that volumes also increased in periodic auctions last month. Average daily notional was more than €1bn ($1.1bn) for the first time since since October 2018. Periodic auctions accounted for 2.4% of on-exchange activity, compared with 2.2% in March according to Tabb.

Periodic auctions are different from the traditional opening and closing auctions on exchanges as they can last for very short periods of time during the trading day and can be triggered by market participants, rather than the venue. They are considered to be lit trades under MiFID II, as the indicative matched size is published prior to execution.

The European Securities and Markets Authority issued a call for evidence on periodic auctions in November last year as the regulator said there are concerns that frequent batch auctions may be used to circumvent the double volume caps. However, market participants largely responded that they value the function played by periodic auctions in the market.

Johnson said that more than three quarters of buy-side desks are using periodic auctions. “There is broad satisfaction, with 40% noting they have had a good or excellent experience, as opposed to 7% with a negative opinion,” he added.

Systematic Internalisers

MiFID II banned broker crossing networks and required broker-dealers to set up systematic internalisers in order to provide principal liquidity to clients.

Cave said there was also a significant increase in activity on SIs last month, particularly above the large-in-scale thresholds. Addressable daily notional SI volumes totalled €9.6bn last month, compared with €7.7bn in March according to Tabb.

Greenwich Associates added that SIs are now capturing about 14% of all buy-side flow and have proved a popular venue for institutional investors to access liquidity. The survey said almost 90% of buy-side traders are connected to at least one SI, with Bank of America Merrill Lynch, JP Morgan and Goldman Sachs having the highest penetration.

“The popularity of SIs in Europe will likely not end there,” said Johnson. “Now that they have demonstrated their ability to satisfy buy-side demands for liquidity and offer a way for brokers to differentiate themselves, we may see them spread to other markets.”

More data

However Healey note that the overall proportion of liquidity migrating to systematic internalisers and periodic auctions still remains less than the activity in the closing auctions. Periodic auctions represented only 2% of total market volume and SIs’ around 15% in the first quarter of this year, according to Liquidnet.

“Given the current Esma review on frequent batched auctions as well as forthcoming amendments to SI regulation, these market share percentages are likely to change as liquidity formation adjusts accordingly,” she added. “While liquidity is not yet shifting back to the continuous lit market, it is being repackaged as the sell side connects to new sources of liquidity in a bid to deliver enhanced execution.”

Healey continued that future disruption and innovation in European capital markets is likely to come from increasing use of data and analytics.

“One of the biggest changes in trading strategies since MiFID II has been the growing focus on transaction cost analysis as the buy-side continually seek to understand brokers execution strategies and focus on implicit as well as explicit costs of trading,” she added. “The requirement now is for solutions which provide the buy side with a truly independent means of analysis alongside analysis provided from execution partners.”