FCA’s Wheatley: UK has a dozen ‘dark pools’

Most of the largest UK banks operate at least one trading dark pool, with 12 of the intra-business trading systems regulated by the FCA.

FCA chief executive Martin Wheatley told the House of Commons Treasury Committee on Tuesday that all of the major banks have a dark pool, including Barclays, Deutsche Bank, UBS, Credit Suisse and Goldman Sachs.

A dark pool is an internal trading engine that matches trades internally to hide large trades from the open market, where large orders could shift prices.

The boss of the financial markets watchdog was cross-examined by MPs about the phenomena of high frequency trading and shrouded markets that have caused controversy in the US.

Michael Lewis’s Flash Boys, which details the rise of high frequency traders, claims the industry was effectively skimming billions of dollars off of ordinary investors’ trades. It also made claims about the rectitude of the large banks’ dark pool trade matching systems, saying they were not operating in the client’s interest.

Wheatley told the committee that the UK market sported a dozen regulated dark pools.

There may be other, foreign exchange, darkpools that do not have to be regulated.

Dark pools are more prevalent in fixed income and forex markets, however that has always been the case because of the lack of a central market, he explains.

“That’s slightly different from the concept of a darkpool, which is largely about the technology as to how it’s delivered.”

“But yes, in debt markets and forex markets the really large players try to internalise as much flow as they can because there isn’t a public market for business to go into.”

In the US, high frequency traders with access to dark pools can use small orders to discover larger chunks of securities, among other strategies. They then use that information to their advantage in other markets.

Wheatley told MPs that high frequency trading accounted for 30 per cent of UK equity market volumes, higher than Europe, much lower than the US.

Market abuse is less likely in the UK, because it is less fragmented: 60 per cent of UK, the New York stock exchange has less than 20 per cent, he says.

The exchanges here have not created the order types that were developed in the US to favour high frequency traders, he adds.

The US market has a unique system – The Reg NMS system – that forces orders to be handled in a way that can be exploited by high frequency traders.

The British Best Execution rules are more complex and harder to create algorithms round, he says.

Also, the chance of a “rogue algorithm” causing a massive, fleeting loss in minutes – a “flash crash” such as the 1,000-point plunge in the Dow Jones Industrial Average in May 2010 – is just as possible in the UK.

However, the regulator enforces and oversees the fail-safes built into the systems.