Chapter 8 - Alternative Trading Venues Flashcards
What is the first US example of an alternative trading venue?
When was it launched?
“Electronic Communication Networks” (ECNs)
Launched by the SEC in 1998
What was the original purpose of an ECN?
Create more competition between trading firms by lowering costs
Offer order matching outside of traditional hours
Why is the term “trading venue” confusing
Despite being called a venue they have no actual physical location
What did the original MiFID aim to do?
1) Harmonise Markets
2) Increase Transparency
3) Better Price Discovery
4) Verify brokers are following best execution rules
What did MiFID II add?
1) Controls to prevent market abuse
2) Improve transparency further
3) Increase scope beyond equities (ETFs, bonds, ADRs etc)
What is an MTF?
A multilateral trading facility
What does an MTF do?
Offers an alternative trading venue to formal exchanges which brings together buyers and sellers.
Who can use MTFs?
Retail and Institutional Clients
What can be traded on MTFs?
Shares, Bonds Derivatives + More
How does MiFID II regulate MTFs?
Same as regulated markets
What must be in place in MTFs and what must they ensure?
- “system and controls” to ensure “performance is adequate, effective and appropriate
What must MTF operators ensure they avoid?
Conflicts of interest
How is transparency ensured on MTFs?
Pre and post trade requirements
(buyer and seller pre)
(seller post)
What basis are MTFs ran on?
“non-discretionary”
Cannot interact with parties contract
How is fairness ensured in MTFs?
A set of clear transparent rules for all parties
These rules set the basis for the “non-discretionary” basis to work.
What are the 3 benefits of MTFs?
1) Non discretionary - no special treatment for firms
2) Transparent pricing (pre/post reporting)
3) MiFID Compliant
What is an OTF?
Organised trading facility
How does an OTF differ from an MTF?
OTF:
- Can be discretionary
- Cannot trade equities
What is the advantage of OTFs?
1) Provide liqudiity and price discovery to illiquid assets and markets
2) OTFs must monitor members under their transparent rules
What is a systematic internaliser?
A financial institution which exectures its clients orders on its own account
When does a FIG qualify as a SI?
Taking ordres on a:
1) Frequent
2) Systematic
3) Substantial Basis
dependant on the security and its liquidity,
If considered a systematic internalizer what must be done?
Firm must adhere to the pre and post trade transparency as MTFs and OTFs
You are considered an exchange if deemed to be a si
What is a dark pool?
A forum to trade securities in a non-displayed nature
Size, direction and identity and not displayed
What is the motivation behind dark pools?
Who uses them most commonly?
Do not want to indicate position / stratergy to the market.
Large financial institutions (particuarly hedge funds)
Hedge funds want stratergy to remain secret.
Prevents front running
How much of trading volume do dark pools make up in:
1) UK
2) US
1) 9%
2) 18%
What are criticisms of Dark pools?
No longer reflect price of securities
Playing field isn’t level for smaller investors
What has the SEC done to address dark pool criticisms
Launched biggest trading rule overhauls - aim is to level the playing field
announced 2022 - undergoing implementation
What are the three types of Dark Pool
1) Broker-Dealer owned
2) Exchange Owned
3) Electronic Market Makers
What is a broker-dealer-owned dark pool?
Set up by broker-dealers: (usually IBs)
Own traders as well as clients use them
What is an exchange owned dark pool?
Ran by an exchange - act as agents and not principals
What is an Electronic Market Maker Dark Pool?
Independant dark pools - usually offer lower transaction costs (can operate as principals)
How are assets priced on Dark Pools?
Mid Point
Spreads differ from public exchanges
Give 4 Advantages of Dark Pools
1) Annonymity for Firms
2) Large deals have reduced effect on the market
3) Trades can have cheaper fees
4) No indication of strategy / direction - prevents front running
Give 5 disadvantages of dark pools?
1) Actual prce not available on market
2) Cannot determine if trade done at “best price”
3) HFTs can unearth large orders to arbitrage
4) Actual size of trades small - on average 200 shares
Give two ways in which dark pools differ from traditional markets
Broadstrokes, they operate very similarly
1) Liquidity is hidden (no need for iceberg orders)
2) Do not need to provide data to markets
What is the impact on markets of dark pools?
1) reduction in impact of large trades
2) Financing for dark pools is taken from major markets (reduces their liquidity)
3) Hard to value assets under true and fair accounting
Give two controversies surrounding Dark Pools
1) Lack of regulation
2) HFTs can use predatory practices to front run
How has the US regulated dark pools?
SEC & FINRA made more information from dark pools available to public
Fined banks for misleading practices
How has the EU regulated dark pools?
Certain names barred from being traded on dark pools
4% of trading in a single stock per dark pool
8% across all dark pools
once cap is reached, trading on dark pool is prohibited
What is a ping pool?
Same as a dark pool but:
- Single counterparty
- Brokers can enquire as to who is involved
- Transparency & regulation is more opaque
Less transparency - causes concern for some participants
