Trading on dark pools in Europe has reached a record since MiFID II went live at the start of last year despite the European Union regulation aiming to shift volumes onto lit exchanges.

Tim Cave, analyst at consultancy Tabb Group, said in a report that dark MTF volumes last month had a daily notional of €4.4bn ($4.9bn), up 26% on September.

Tabb’s European Equities LiquidityMatrix added: “Dark MTFs accounted for 10.4% of on-exchange market volume, a record high by our estimates under MiFID II.”

The overall daily notional for equities trading was €62.6bn last month, down 13.4% on October last year.

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 continued that electronic liquidity providing SI daily notional volume also reached a record €1.5bn last month. This was driven by a significant uptick in volumes from XTX Markets, a quantitative-driven electronic market-maker providing liquidity in equities, foreign exchange, fixed income and commodities.

We are now the No.1 Systematic Internaliser in Europe by volume.
Demonstrates the effectiveness of our pricing & risk holding/low market impact approach.
Aligned with our top 3 status on various equity exchanges globally – it has been a successful year of growth in equities! https://t.co/Y3Lkt7yTsU

— XTX Markets (@xtxmarkets) November 20, 2019

“Overall, ELP SIs accounted for 2.4% of overall volume during the month, the same figure as September,” added Cave.

Institutional liquidity pool Liquidnet said in its MiFID II Liquidity Landscape report for the third quarter that SI activity dropped significantly in the first quarter of this year but has since picked up.

“The recent rise in activity could comfort regulators’ view that in the event of a hard Brexit, the enforcement of the EU share trading obligation will push more volumes to European SIs – indeed there has been a significant increase in the number of European SIs registering versus last year,” added Liquidnet. “Although MiFID II reiterates that SI trading activity should be characterised by risk-facing transactions that impact the profit and loss account of the firm, if the regulators perceive the use of SIs as a means to match orders across jurisdictions, this will likely draw further scrutiny and potential regulatory tightening.”

There has been a dispute between the European Securities and Markets Authority and the UK  over the scope of their respective share trading obligations once the UK leaves the European Union.

In March Esma announced that after Brexit, EU firms will have to trade certain shares and derivatives on EU or equivalent venues, even if most liquidity is currently in London. The UK Financial Conduct Authority warned at the time that this would conflict with the UK’s own share trading obligation. In May Esma said the share trading obligation would not be applied to 14 UK shares included in its previous guidance but the requirements for dual listed shares after Brexit have not been agreed.

Nausicaa Delfas, executive director of international, and member of the executive committee at the FCA, said at a conference last month that the UK regulator is continuing to discuss dual listed shares with Esma as restricting trading after Brexit will increase costs for investors.

Periodic Auctions

Periodic auctions accounted for 2.8% of on-exchange volumes last month according to Cave, the third-highest level under MiFID II and the highest since March last year.

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.

Esma 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 initiated under MiFID II.  The caps aimed to shift trading to lit volumes by limiting the amount of dark trading in a stock. 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.

Esma’s recent opinion shows that the European regulator aims to tighten and limit the conditions under which periodic auctions can operate according to Liquidnet.

“While European regulators acknowledge that periodic auctions respond to a need in the market, what remains of concern is the use of these systems to circumvent the double volume caps, preventing activity returning to lit markets,” added Liquidnet. “While periodics still only represent approximately 2% of activity, the use of these constructs along with an increased use of SIs did limit the downside impact of the DVC – just 63 shares have breached the latest 8% EU-wide cap and are suspended for a six-month period.”

Liquidnet warned that end investors may suffer while the market is forced to adjust to new alternative execution methods and if trading costs increase.

Closing auctions

The share of daily trading in closing auctions in Europe has risen from 10% to 12% a few years ago to 25% of lit market volumes in September this year according to Liquidnet.

“While the success of these auctions is the direct result of the growth of index investing and exchange-traded funds, participants also feel they get a fairer deal than on continuous lit order books,” added Liquidnet.

The French regulator, the Autorité des Marchés Financiers, noted that the closing auction reached 41% of the volume traded on Euronext Paris for CAC 40 stocks in June this year.

“While the AMF cite the rise in trading activity on the close is due to an increase in passive management, the desire to avoid high-frequency trading, and a rise in algorithmic trading, they also note the increase in best execution obligations under MiFID II to provide end investors with greater transparency regarding transaction costs and market impact may be encouraging more at close activity,” said Liquidnet.

Tabb noted that Turquoise Plato is planning to launch its Market-On-Close order type early next year and is consulting with members on the final model so it does not distort the closing price formation process. Turquoise is London Stock Exchange’s MTF and has a venture with Plato Partnership, the non-profit sellside and buy-side organisation.