Quasi-Dark Trading: The Effects of Banning Dark Pools in a World of Many Alternatives

Abstract

We show that "quasi-dark" trading venues, i.e., markets with somewhat non-transparent trading mechanisms, are important parts of modern equity market structure alongside lit markets and dark pools. Using the European MiFID II regulation as a quasi-natural experiment, we find that dark pool bans lead to (i) volume spill-overs into quasi-dark trading mechanisms including periodic auctions and order internalization systems; (ii) little volume returning to transparent public markets; and consequently, (iii) a negligible impact on market liquidity and short-term price efficiency. These results show that quasi-dark markets serve as close substitutes for dark pools and consequently mitigate the effectiveness of dark pool regulation. Our findings highlight the need for a broader approach to transparency regulation in modern markets that takes into consideration the many alternative forms of quasi-dark trading.

Frequent Batch Auctions Under Liquidity Constraints

“…In line with Johann et al (2019), we find that stocks experiencing DVC-imposed dark trading restrictions experience higher periodic auctions volumes and that the overall market quality effects of periodic auctions on the market are limited and mixed. Specifically, we find that periodic auctions have a generally positive effect on liquidity and a largely benign effect on adverse selection costs, except in the case of the most liquid stocks, where adverse selection declines with the use of periodic auctions.…”

“…An FCA (2018) investigation of the growth of periodic auctions in UK stocks finds little difference in growth between stocks experiencing dark trading caps and those that are not. Johann et al (2019) investigate the shift of dark pool volume to other non-continuous trading mechanisms following the imposition of dark trading restrictions on some stocks. They find that only a small proportion of the hitherto dark volume shift into such markets, including periodic auctions.…”

“…The implementation of the DVC might lead to the shift of hitherto dark trading volume to quasi-dark markets, including the periodic auction book (see Johann et al, 2019).…”

“…This results from the commencement of the double volume cap (DVC) measure, a MiFID II provision designed to restrict dark trading in European markets (see Ibikunle et al, 2019 for a detailed discussion of the DVC), in place since early 2018. Evidence suggests that a non-negligible portion of volumes, otherwise destined for dark pools in stocks under the DVC restriction, are executed through periodic auctions and other non-continuous trading mechanisms, the so-called 'quasi-dark' mechanisms (see Johann et al, 2019).…”

“…To the best of our knowledge, this is the first study to provide empirical evidence on the market quality implications of periodic auctions in European markets. Although Johann et al (2019) include periodic auctions in their list of 'quasi-dark' trading mechanisms, the identification of periodic auctions mechanisms as quasi-dark is slightly problematic given that a key feature of auctions is transparency -specifically, the fact that all orders are reflected in the observable indicative auction price and volume as they arrive in the market and prior to uncrossing. European exchanges, such as Cboe, also claim that the orders submitted to their periodic auctions mechanisms are sent to lit order books as they arrive.…”