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Finance: Off-exchange Trading Venues

Volume 729: debated on Monday 18 July 2011


Asked By

To ask Her Majesty’s Government what assessment they have made of the risk to financial markets of off-exchange trading venues commonly known as “dark pools”.

My Lords, the Government strongly support ongoing initiatives at the European and international levels to improve transparency in financial markets. The International Organisation of Securities Commissions, IOSCO, has recently agreed a set of principles for regulating dark pools that will help inform the European Commission’s ongoing review of the markets in financial instruments directive, MiFID.

I thank the Minister for that Answer. He will be aware that Andrew Haldane of the Bank of England, in a speech a week ago, pointed out the dominance of dark pools and their high-frequency trading in many financial markets. Does the Minister agree that the lack of transparency, the price differential suffered by small investors, the implications for corporate governance of nanosecond share ownership and, above all, Andrew Haldane’s concern that liquidity could disappear rapidly in times of stress all point to a serious risk to financial stability? Will he continue to follow the issue and look at more action by the British Government, not just at the European level?

My Lords, we should distinguish—as I am sure my noble friend Lady Kramer does—between the two issues of dark pools and high-frequency trading, both of which I am sure noble Lords are very familiar with. Dark pools are akin to what used to be called “upstairs trading”—off the floor of the Stock Exchange. We need to make sure that the benefits of being able to trade in such an environment, such as competition and choice for investors, do not impinge in any way on the transparency and the price-discovery ability of markets. The FSA has done work on that and is content that the price-discovery mechanism is not being damaged.

High-frequency trading is a very new and slightly separate area, although I agree that it is related, and it is one on which the Government are doing considerable work. A research project led by the Government Office for Science is looking at the possible evolution of computer-generated trading and its implications, and will produce up to 20 papers on the subject during 2011.

Are dark pools the same as dark matter, which the astrophysicists tell us permeates the universe but which no one can observe? Is not the problem that for a considerable period banks and other financial institutions marketed paper assets that had no real assets behind them, and that that is what led to the financial crisis? Is it not more worrying that the banks cannot wait to get up to the same tricks again, and will do so if something is not done to regulate them properly?

My Lords, I am no great expert on dark matter and black holes, but I think the distinguishing point about dark pools is that they are a venue for trading that enables confidential orders to be submitted and matched using a reference point that comes from a transparent market. As soon as the trade is done, the details are reported publicly. Therefore, there is confidential trading and then full reporting, which is the critical feature of the market. Various platforms are available for the market, which accounts for something of the order of 7 per cent of UK and European equity trading. It is not a dominant part of the market by any means, but it is one that we are watching.

My Lords, one of the best moves in the mid-1990s was the creation of the alternative investment market, AIM, which has been a great success. I was a director of an AIM company that is now a FTSE 250 company. However, the biggest problem with AIM was always liquidity. Liquidity is an also issue outside the FTSE 250 on the main market. Can the Government do something to improve liquidity? Should more be done or are they happy with the situation?

My Lords, I certainly agree that mechanisms that help liquidity such as dark pools, which are run by investment banks, multilateral trading facilities or independent operators, are indeed aids to liquidity if they form a proper part of the market. The proponents of high-frequency trading, too, cite them as an aid to liquidity. I completely agree with the noble Lord, Lord Bilimoria, that the last thing we want for example the European Commission to do is to restrict sensible increases in liquidity in our markets without looking at the evidence base that needs to be assembled.

Does the noble Lord agree that we can all relax on this question, because we surrendered supervision of our financial services—

Yes, my Lords, and to the biggest black hole of them all in the shape of the European Commission. Do the Government agree that we can surely rely on this body to come up with an honest solution to any problem, if only because it has not been able to get its own accounts signed off by its internal auditors for the last 16 years?

My Lords, I certainly do not think we should relax on the issue of high frequency trading. We only have to think back to the events of 6 May 2010. I do not need to remind your Lordships that there were two crashes on that day: one was the crash of the outgoing Government; the other was the so-called flash crash in which the Dow Jones index plummeted in a number of minutes by 9 per cent but fortunately, unlike the Labour Government, recovered by 9 per cent a few minutes later. We certainly take this issue very seriously but we need to continue to do the work and see where this leads us.

My Lords, I think the country should be on its guard when euphemisms such as “black pools” are used. I agree with the noble Lord that they are an aid to liquidity but he will know—and I am grateful to him for identifying that the Government are expressing some anxiety in this respect—that they restrict transparency in the marketplace. We all know the price that we have paid for a lack of understanding of what has gone on in the world of finance and the importance, therefore, of the Government being concerned to get as much openness and transparency as they can.

My Lords, if they were black holes as the noble Lord suggests, we would be worried, but for dark pools, IOSCO, the international regulatory organisation, has recently laid down six principles to guide the operation of the regulatory framework of dark pools, and the FSA’s assessment is that the UK and the EU are fully compliant.