Background on the Dark Pool Thematic Review
On July 21, 2016, the Financial Conduct Authority (FCA) issued a thematic review - TR16/5: UK equity market dark pools – Role, promotion and oversight in wholesale markets - which examines how dark pool operators promote their services and how they manage conflicts of interest.
Equity market dark pools are not a new invention. However, dark pools have recently gained adverse publicity particularly in relation to price transparency and the potential information asymmetry some operators or technologically advanced users may use to manipulate the market. This is partly due to a lack of understanding of how the equity markets have evolved the function of a dark pool and the assumption that all dark pools are the same.
The FCA met with a number of firms that are users, operators or provide access to dark pools in order to understand the roles and responsibilities of each party to the trade.
Who is this Review Relevant to?
This review is most relevant to asset managers, operators of Broker Crossing Networks (BCN) and dark pools, Multilateral Trading Facilities (MTF) and other firms operating trading venues and exchanges.
Key Findings and Recommendations
The FCA has provided examples of good and poor practices as well as a list of questions both operators and users should think about, as summarized below:
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Operators need to provide clear detail as to the design and operation of a dark pool
The service offerings should be clear, fair and not misleading. -
Operators should improve the monitoring of their dark pool
The operator should have adequate controls and oversight to ensure the features operate as designed and intended. -
Operators should do more to identify and manage conflicts of interest (including both client vs. client and operator vs. client)
Many operators offer access to a dark pool as a standard item of a wider generic agreement. The FCA expects the operator to have specific dark pool policies and procedures, membership controls and order restrictions and prioritization. -
Operators should improve governance and the strength of the second line of defense
The second line of defense should have sufficient technical expertise to be able to challenge, guide and support. -
Users should be clear about their rationale for using or not using dark pools
They should conduct adequate due diligence to ensure it understands the operating model to be able to monitor ongoing activity. -
Both the users and operators should remain alert to risks
As markets evolve and adapt, new forms of conduct risks will inevitably emerge resulting in regulatory and managerial and operational challenges.
Moreover, whilst best execution was not the focus of this review, the FCA clearly states best execution obligations whether on lit or dark markets. The FCA would like to see the operators of dark pools engage with users more and provide more useful information on how the orders are routed and executed and useful statistical information. For example, millisecond clock speeds.
How Duff & Phelps Can Help
Duff & Phelps is an award-winning global provider of compliance and regulatory consulting services to the financial services industry. Clients consult our team of specialists at every stage of their business lifecycle to meet regulatory obligations and navigate the rapidly changing regulatory landscape. Our multidisciplinary team is drawn from leading financial institutions, regulators, government authorities, legal and advisory firms.
Based in key financial centers, we are closely connected with regulators and industry associations so that our clients have the best available information on regulatory requirements and trends. We operate seamlessly across borders to provide clients with cross-jurisdictional advice and integrated expertise.
Through our industry experience and client engagements, we can offer a practical insight into the common challenges and areas for improvement from both a dark pool user and an operator perspective. We can assist both dark pool users and dark pool operators by:
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Reviewing conflicts of interest management
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Assessing monitoring and surveillance arrangements
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Reviewing governance and oversight arrangements
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Reviewing policies and procedures
