LONDON (Reuters) - European fund managers, increasingly aware of the risks of trading in anonymous, private venues known as “dark pools”, are pushing for better oversight and security as regulators step up scrutiny of the industry.
This underscores how many investors are unwilling to give up on the potential price and performance advantages of trading anonymously - particularly at a time of renewed financial market volatility - and are instead clubbing together to find alternatives.
One working group created this year, which today represents some 30 investors, including Barings and AXA Investment Management, has advocated urgent change in how dark pools work. The changes would help to ensure certain kinds of high-speed electronic traders are kept at arm’s length and to better police trading.
The group advocates, among other measures, a minimum order size. That acts as a natural barrier to entry for some high-speed trading algorithms, which use orders for small lots to identify interest to try to front-run orders. It also gets closer to the minimum size European regulators plan to impose.
The group worked with the London Stock Exchange on its new dark-pool service for large orders on its Turquoise platform.
“The feeling among the buy-side (investor) community is that dark pools themselves, aside from changes in regulation, urgently need changing,” said James Cooper, the head of execution at Troy Asset Management, a member of the group.
“We really felt the urgency here to take the opportunity ... to shape a product that would best suit our needs.”
Dozens of dark pools have sprouted up since the 2008 financial crisis, offering anonymity for those looking to trade blocks of shares without moving markets.
However, their lack of transparency has brought on heightened regulatory scrutiny. Several regulators are investigating dark pool operators, and New York’s attorney general is suing Barclays, accusing it of securities fraud for activities related to its dark pool.
European regulators have proposed caps on the amount of dark-pool trading in any given stock below a certain order size as part of a set of rules due to be implemented by 2017.
The responses within the industry have been varied. U.S. bank Wells Fargo recently chose to close its dark pool, citing a lack of demand. But fund managers are trying to find solutions, with some going so far as to design their own systems to navigate different trading venues.
Other broker-owned venues have begun to offer minimum-size services, but the investors involved with the new Turquoise block-trade service think the fact that it is operated by a public exchange, rather than a bank, is an advantage.
“We were keen for this to be on a public venue so that it can be accessed by institutions or any investor, including the sell-side (brokers),” said Adam Conn, head of trading at Baring Asset Management.
Fund managers and technology consultants are quick to point out that there is no utopian dark pool that will fulfill everyone’s needs - more aggressive, short-term-minded hedge funds will have different requirements to these big investors.
But the post-crisis structure of automated electronic financial markets is being tested by rising volatility amid fears over the global economy. Fund managers want the dark-pool industry to improve transparency and security and shore up confidence rather than disappear.
“Markets are very technologically advanced now, very complex and it is not very easy to understand what is going on when you send an order to the market to be executed,” said Paul Squires, head of trading at AXA IM.
Citing extra regulatory pressure even on fund managers to deliver the best prices for clients, he added: “There is a shift of responsibility, maybe, from sell-side to buy-side.”
Reporting by Lionel Laurent and Clare Hutchison; Editing by Larry Kiong