the tick-size regime. Without any
restrictions on tick sizes, an SI can
tick inside an exchange or MTF by
increments that are smaller than
the tick increment and smart order
routers would have to direct business to the SI for Best Execution.
However, investment banks have
had to restrict and reduce their
proprietary activity because of the
Basel III capital adequacy regulations. Credit risk departments will
always have a say on restricting the
amount of capital banks are able to
commit to trades.
The firms that are probably more
likely to make the SI regime work
are HFT/ELP firms. Trading in
small clip sizes is their forte. Investment banks are likely to thrive
in trades above standard market
size (SMS) up to large-in-scale
(LIS) dark trading. By contrast,
HFT firms will be able to provide
competitive liquidity (possibly
directly to the buy-side in some
cases) in smaller sizes.
Only Large in Scale (LIS) trades
benefit from dark liquidity
Dark trading has risen to somewhere between 8% to 15% of the
equity market. Regulators have realised that it has a positive purpose,
for trading LIS particularly.
Trading on dark order books
Agency broker SOR vs. investment
will be drastically reduced by the
double volume cap (DVC) which
regulators have imposed for dark
pool trading. This is relatively
uncontroversial for a liquid stock
like Vodafone, which could have
a quarter of a percentage point
spread and easily migrate to a lit
order book. However DVCs for less
liquid FTSE 250 stocks, for exam-
ple, are less satisfactory.
Less liquid stocks might have
spreads of one to three per cent or
more. Trading even a small clip in
the dark, with a mid-point match,
minimal leakage, no exchange fee
and the saving on spread capture,
a trader could be saving a consid-
erable amount upon execution.
Migrating that trade to a lit order
book is not ideal, and those stocks
will be most affected by the caps.
It is important to remember that
SIs only have to be transparent
up to SMS, after which they are
effectively dark liquidity providers.
Clients can stream quotes from
SIs for anything larger than SMS
and effectively trade in the dark
with nobody in the market seeing
their order. So there will still be a
way to trade under LIS and reduce
A buy-side firm using a SOR via
an investment bank will get a very
different result versus going via
an agency broker SOR. Agency
brokers are going to have the
ability to stream prices from and
connect their SORs to a vast array
of SIs which will improve liquidity
access. Banks will not normally
connect with rival banks, therefore
limiting SI access.
Buy-side firms might be mind-
ed to go down the agency broker
route because they are going to
connect to more venues. However,
the more SIs they connect to the
greater the information leakage.
When an agency broker plugs into
multiple SIs under MiFID II they
are showing order flow to multiple
By contrast, investment banks,
on balance, offer less information
leakage as a result of connecting to
fewer SIs, but possibly at the expense of quality liquidity capture.
Buy-side firms will have to look at
the type of trades they are doing,
where they are trading and the
type of names they are trading in.
Having a conversation with existing DMA providers now about how
they see their routing configurations changing in 2018 will avoid a
lot of cost after the rules kick in.
director, head of trading, Pershing
can give the buy-side
trading desk different
angles of approach on
the new market.”