Hitting the bullseye

According to recent press articles, the MiFID II trilogue has agreed on capping dark trading at an arbitrary 4% per venue and 8% overall market share. At the heart of the discussion around dark trading lies the role of transparency in the wider market. While one side claims that transparency is the only thing that can keep fragmented markets efficient, the other side worries about the undue restriction of legitimate and long-standing business practices. Whichever way you look at it, the new rules stand little chance of making either side happy.

Firstly, the thresholds of 4% and 8% seem fairly random, with little empirical evidence to back them up. As Markus Ferber pointed out: “This is an area where no one has any experience because no data is available. It is not that easy to agree on a volume cap if you don’t really know what’s going on.” And if we can’t measure things now, how are we going to measure them in the future?

These thresholds will be written into the Level 1 text. Given that it took European legislators about ten years to review MiFID I and agree on MiFID II, it seems strange that they could so quickly move to set their guestimates in stone for the next decade. Why legislators can’t simply leave it to ESMA to come up with sensible thresholds, specific to instruments or instrument groups, remains a mystery.

Let’s hope that the trilogue hits the bullseye when it comes to dark pool thresholds. Otherwise, we might find ourselves wishing for MiFID III even before MiFID II is fully implemented.

One Response to “Hitting the bullseye”
  1. Subhashish Saha says:

    A sacrosanct limit of 4% or 8% on the dark trades can at best be called as an instance of “Looking for a tennis ball under the lamp post”. Here is how I would argue that: The raison d’être for markets is efficient price discovery and all other factors should be viewed in the context of whether it enhances or impedes efficient price discovery. Transparency should also be viewed in the same context. It has been proved beyond reasonable doubt that market liquidity enhances price discovery. Hence the effect of transparency (Both Trade and Quote) on market liquidity has to be seen. The erstwhile Securities Investment Board (SIB) had argued that there is “a tradeoff between liquidity and trade transparency”. The presumed tradeoff arises because knowledge of trades may expose market makers to undue risk as they unwind positions and consequentially “Transparency should be restricted if this is necessary to assure adequate liquidity”. This hypothesis was supported by the seminal research of Bloomfield and O’Hara – “Market Transparency: Who wins and Who looses?”. Thus it is clear that transparency has to be dynamically adjusted to Market liquidity/illiquidity and a sacrosanct limit of 4% or 8% on dark trades may adversely affect the market liquidity and efficient price discovery. A way out of this can be to reverse calculate the transparency variable given the liquidity variable. But that is easier said than done – An interesting theme for research and only then we find our tennis balls.

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