One of the goals of the MIFID2/MIFIR regulatory package was to reduce dark trading – both pre-trade darkness and post-trade darkness.
Indeed, regulators across the globe have been critical of the growth of such type of trading, as arguably it does not contribute to price discovery nor to publicly available market liquidity – note that if all dark trading moved into lit platforms, there would be more orders contributing to the public price formation, more displayed liquidity (i.e., narrower bid-ask spreads and higher depths) and more available data on executed transactions (which allow for a better-informed price formation).
In addition, some regulators also argue that having no (or limited) pre-transparency requirements for OTC trading creates unfair competition between investment firms (IF) and trading venues (TV), while having no (or limited) post-transparency requirements creates unfair competition between the investors that are knowledgeable about a certain transaction and those investors that are not.
Please find below a summarized (and simplistic) explanation of what changed with MIFID2/MIFIR in regards to what can be dark traded:
Basically, MIFID2/MIFIR introduces three major changes toward restraining dark trading:
However, light has not come in abundance...
In spite of the above-mentioned changes, different sources reveal that the trading venues’ market share barely changed with the implementation of MIFID2/MIFIR. The pure OTC’s market share did fall abruptly, but it was basically replaced by a strong growth in the Systematic Internalisers’ market share. Note that the number of registered SIs increased from 14 in pre-MIFD2/MIFIR to over 100 in post-MIFID2/MIFIR.
Note that, in spite of this admitted failure, transparency did increase (even if in a limited way, as many argue), both in: a) OTC trading, since it was partly funneled to SIs; b) equity-like and non-equity instruments.
Nonetheless... the question is... if regulators are disappointed with the lack of growth in lit trading venues, are they preparing a MIFID3 with stricter pre-trade transparency requirements for systematic internalisers?
Indeed, regulators across the globe have been critical of the growth of such type of trading, as arguably it does not contribute to price discovery nor to publicly available market liquidity – note that if all dark trading moved into lit platforms, there would be more orders contributing to the public price formation, more displayed liquidity (i.e., narrower bid-ask spreads and higher depths) and more available data on executed transactions (which allow for a better-informed price formation).
In addition, some regulators also argue that having no (or limited) pre-transparency requirements for OTC trading creates unfair competition between investment firms (IF) and trading venues (TV), while having no (or limited) post-transparency requirements creates unfair competition between the investors that are knowledgeable about a certain transaction and those investors that are not.
Please find below a summarized (and simplistic) explanation of what changed with MIFID2/MIFIR in regards to what can be dark traded:
Basically, MIFID2/MIFIR introduces three major changes toward restraining dark trading:
- Pure OTC was partially forbidden (only infrequent and unsubstantial trading is allowed) – in more precise terms, all IFs pursuing frequent/systematic and substantial OTC trading were forced to become either an SI (only for transactions in which IFs trade with their own capital) or a trading venue, and thus become subject to the respective pre-trade transparency requirements and post-trade transparency requirements;
- Equity-like and non-equity instruments are now also subject to pre-trade transparency requirements and post-trade transparency requirements – dark trading in such instruments can now only occur within the scope of the pre-trade transparency requirements' waivers and the post-trade transparency requirements' deferrals;
- Unlimited trading with pre-trade darkness in equity and equity-like instruments at TV can now only occur for large orders (Large-in-Scale waiver) or iceberg/hidden orders (Order Management Facilities waiver) – as the usage of the other two pre-trade requirements' waivers, the Reference Price waiver and the Negotiated Transactions waiver, is now limited/caped (Double Volume Caps).
However, light has not come in abundance...
In spite of the above-mentioned changes, different sources reveal that the trading venues’ market share barely changed with the implementation of MIFID2/MIFIR. The pure OTC’s market share did fall abruptly, but it was basically replaced by a strong growth in the Systematic Internalisers’ market share. Note that the number of registered SIs increased from 14 in pre-MIFD2/MIFIR to over 100 in post-MIFID2/MIFIR.
The AMF (Autorité des Marchés Financiers), the French financial markets’ authority, showed its disappointment with such trend in both its 2018’s and 2019’s Markets and Risk Outlook. Indeed, regulators expected SI to grow somewhat with MIFID2/MIFIR, but not in such way… which suggests that investment firms are using the SI regime to circumvent the trading venues’ increased pre-trade transparency requirements and the new tick-size regime.
Indeed, SIs’ pre-trade transparency requirements are much more lenient than the trading venues’, as: i) SIs are not subject to the double volume caps; b) SIs’ standard market size waiver is much more permissive than the trading venues’ large in scale waiver. In addition, SIs are not subject to the tick-size regime, meaning that those who trade at SIs can improve the best bid or best ask with very small price increments.
(It has been reported that, after having initially surged, SIs’ market share fell – though, still staying at significant levels. However, such share of trading was not directed into trading venues but instead back into pure OTC. According to some reports – including AMF’s, during an initial phase, investment firms did not fully understand the new MIFID2/MIFIR requirements and over-allocated OTC trades into SIs… and, as their understanding improved, they partially reverted such trend. Nonetheless, the main point remains intact: trading venues' market share barely changed, and the decrease in pure OTC trading was compensated by a rise in SI trading.)
Note that, in spite of this admitted failure, transparency did increase (even if in a limited way, as many argue), both in: a) OTC trading, since it was partly funneled to SIs; b) equity-like and non-equity instruments.
Nonetheless... the question is... if regulators are disappointed with the lack of growth in lit trading venues, are they preparing a MIFID3 with stricter pre-trade transparency requirements for systematic internalisers?
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