ECB trading rules spark warning over dark pools
New regulations designed to make trading more transparent may bring about opposite effect in fixed-income markets
New regulations designed to make trading more transparent may have the opposite effect by encouraging the emergence of so-called dark pools in fixed-income markets, the European Central Bank said.
In a report on financial stability, the ECB called for more study of the development and potential effects of dark pools 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 prefer dark pools to avoid revealing intent and trading with more informed counterparties.”
Asset managers in recent years have turned to electronic platforms to buy and sell large blocks of bonds anonymously. That is partly because banks have pulled back from the business of wholesaling debt amid rising regulatory costs. Credit Suisse Group shook Europe’s bond markets last month with the 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 rein in the use of dark pools for equities trading.
Dark pools 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 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 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. “Dark pools for fixed-income instruments may emerge, pooling together liquidity and further changing the structure of these markets.”
Daily trade on a type of dark pool known as dark order books had increased from less than 1 per cent in 2010 to more than 8 per cent 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.