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FSA Considers Classifying Broker Dark Pools as MTFs

The UK's financial services regulator is turning its focus to internal dark pools operated by investment banks, weighing whether they should be classified as MTFs under MiFID.

I recently heard that the UK's Financial Services Authority has been eyeing dark liquidity pools operated by investment banks to figure out whether their internalization engines should be reauthorized or registered as MTFs - systems to buy and sell financial instruments - under the Markets in Financial Instruments Directive or MiFID.Big investment houses that operate internalization engines seem to have processes and workflows that are no different than other agency brokers that operate alternative trading systems that have registered as MTFs under the EU's Markets, suggested one agency brokerage source.

The likes of Goldman Sachs, Citigroup, Credit Suisse and UBS operate internal liquidity pools for European stock trading.

"Certainly now the FSA is turning their focus to the big investment houses and the internalization authorities," observed John Barker, managing director of Liquidnet for Europe, Middle East and Africa in an interview with Advanced Trading. Barker speculated that the FSA is examining what is so different about a broker's internalization engine from say a Liquidnet crossing network, which is registererd as an MTF.

Currently the FSA is talking to the investment houses, which operate their own internal crossing networks for matching European stocks. That will go on another six- to-18 months, estimated Barker. This marks a shift in the FSA's attention, which until this point, was talking to the MTFs about their processes and workflows. In the third quarter of 2008, the FSA began turning its attention to the big investment houses running internalization engines. The regulator wanted to get the MTF's straight first, said Barker.

If this is true, it could be a sign that the FSA is rethinking the classification of dark pools under MiFID. Some of the newer players such as Chi-x, Turquoise, BATS Europe and Nasdaq OMX have become MTFs but these are lit markets, although Turquoise has a dark component. The two leading institutional dark pools, Liquidnet and ITG Europe, were ATSs previously but become MTFs. In addition, NYFIX Euro Millennium, a dark pool for European stocks, already operated as an ATS in the UK, but has become an MTF under MiFID. And on Feb. 2nd, the NYSE Euronext's SmartPool received FSA approval to operate as an MTF for block trading in European stocks.

Brokers will say they use their internal liquidity networks to avoid moving the market with institutional orders. But an article in The Banker, "MiFid Slips into the Dark," from August 2008 suggests that one reason why the investment banks are sending orders into their own dark liquidity pools is to save the cost of paying fees to MTFs. And second, the brokers may not be connected yet to MTFs, which is a factor they may not have revealed to their buy-side clients. The article suggests that there has been poor preparation for MiFID and also that changes in the post-trade reporting regime in London have made things confusing.

While MiFID was intended to create a highly transparent single market for Pan-European equity trading, it's possible that the FSA is worried that wthe tendency of brokers to direct client flows to their internal liquidity networks, could be undermining that transparency, according to the article.

The issue was also mentioned by David Doyle, a policy expert on European financial markets, who spoke at The Financial Services Club in London last week, a group for senior executives. According to the Club's blog, Doyle said: "the (EU) Commission now has Hedge Funds and Private Equity in their line of sight, as well as short selling and dark pool equities trading, with a new Directive likely to target this area."The UK's financial services regulator is turning its focus to internal dark pools operated by investment banks, weighing whether they should be classified as MTFs under MiFID. Ivy is Editor-at-Large for Advanced Trading and Wall Street & Technology. Ivy is responsible for writing in-depth feature articles, daily blogs and news articles with a focus on automated trading in the capital markets. As an industry expert, Ivy has reported on a myriad ... View Full Bio

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