Mifid setback EU watchdog delays caps on stock trading in 'dark pools'

A key plank of Europe's new financial market reform is being delayed. The securities regulator fluffed the details of its off-exchange trading rules, even after a year's delay.
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Dark and deeper than it looks.

Europe's biggest financial market overhaul in a decade has hit its first snag. The European Securities and Markets Authority, or ESMA, has unexpectedly delayed the publication of a list of stocks that will be subject to limits on trading in “dark pools,” a controversial and opaque set of non-public exchanges that have come to play a huge role in investing around the world.

The regulator said it was forced to delay the restrictions due to insufficient data, pushing back a mainstay of the EU’s complex new MiFID II rules that came into force on January 3, a year later than originally planned. “The current quality and completeness of the data does not allow for a sufficiently meaningful and comprehensive publication of double volume cap calculations,” ESMA said in a statement late on Tuesday, adding that it expected to be able to publish the data in March.

Dark pools play a tremendous role in today's financial system. According to Thomson Reuters, just over 45 percent of stock volume in Europe now occurs away from public exchanges. The new restrictions, which had been set to come into effect on Friday, are designed to push trading back onto so-called “lit” or fully transparent exchanges, where all investors can see the prices of transactions.

Over 45 percent of stock trading in Europe occurs in dark pools.

Under the new Markets in Financial Instruments Directive II, known as MiFID II for short, the caps will require off-exchange forums to suspend trading in stocks for which, on average, more than 8 percent of daily trading was transacted across dark pools over the past 12 months. The rule is not without controversy: Supporters point out that institutional investors should be able trade large blocks of stocks without impacting the market price against them.

The delay marks the latest last-minute adjustment in an attempt to keep MiFID II on schedule. Public exchanges in five countries – Greece, Norway, Poland, Spain, and Sweden – have been given temporary relief from rules on competition in clearing, the procedure in the securities markets for matching buyers and sellers. Market participants have also been given an extra six months to obtain a so-called security identifier that is required to report trades.

ESMA has been collecting data on dark trading for months, but said the details are still incomplete and that publication now could cause an “unlevel” playing field. “ESMA realized that the publication would have resulted in a biased picture covering only a very limited number of instruments and markets,” the watchdog said. Part of the problem, ESMA acknowledged, was that it had limited time to submit data. The reporting period closed on December 31, and data had to reach the regulator by the close of business on January 5. Instead, ESMA now says it will publish the volume cap data after consulting with trading venues and local regulators.

Brokers and other investors had spent months preparing algorithms and trading systems for the introduction of dark pool caps, and many were poised to apply the limits on Friday. Legally, the caps will still come into force despite the delay, but without the published data to show which securities would be affected, the rule is effectively useless. Probably not the start that European regulators were looking for.

Jeremy Gray is an editor for Handelsblatt Global. To contact the author: [email protected]