Chapter 8 - Alternative Trading Venues

Question 1

What is the first US example of an alternative trading venue?

When was it launched?

Answer 1

“Electronic Communication Networks” (ECNs)

Launched by the SEC in 1998

Question 2

What was the original purpose of an ECN?

Answer 2

Create more competition between trading firms by lowering costs

Offer order matching outside of traditional hours

Question 3

Why is the term “trading venue” confusing

Answer 3

Despite being called a venue they have no actual physical location

Question 4

What did the original MiFID aim to do?

Answer 4

1) Harmonise Markets
2) Increase Transparency
3) Better Price Discovery
4) Verify brokers are following best execution rules

Question 5

What did MiFID II add?

Answer 5

1) Controls to prevent market abuse
2) Improve transparency further
3) Increase scope beyond equities (ETFs, bonds, ADRs etc)

Question 6

What is an MTF?

Answer 6

A multilateral trading facility

Question 7

What does an MTF do?

Answer 7

Offers an alternative trading venue to formal exchanges which brings together buyers and sellers.

Question 8

Who can use MTFs?

Answer 8

Retail and Institutional Clients

Question 9

What can be traded on MTFs?

Answer 9

Shares, Bonds Derivatives + More

Question 10

How does MiFID II regulate MTFs?

Answer 10

Same as regulated markets

Question 11

What must be in place in MTFs and what must they ensure?

Answer 11

• “system and controls” to ensure “performance is adequate, effective and appropriate

Question 12

What must MTF operators ensure they avoid?

Answer 12

Conflicts of interest

Question 13

How is transparency ensured on MTFs?

Answer 13

Pre and post trade requirements

(buyer and seller pre)
(seller post)

Question 14

What basis are MTFs ran on?

Answer 14

“non-discretionary”

Cannot interact with parties contract

Question 15

How is fairness ensured in MTFs?

Answer 15

A set of clear transparent rules for all parties

These rules set the basis for the “non-discretionary” basis to work.

Question 16

What are the 3 benefits of MTFs?

Answer 16

1) Non discretionary - no special treatment for firms
2) Transparent pricing (pre/post reporting)
3) MiFID Compliant

Question 17

What is an OTF?

Answer 17

Organised trading facility

Question 18

How does an OTF differ from an MTF?

Answer 18

OTF:
- Can be discretionary
- Cannot trade equities

Question 19

What is the advantage of OTFs?

Answer 19

1) Provide liqudiity and price discovery to illiquid assets and markets
2) OTFs must monitor members under their transparent rules

Question 20

What is a systematic internaliser?

Answer 20

A financial institution which exectures its clients orders on its own account

Question 21

When does a FIG qualify as a SI?

Answer 21

Taking ordres on a:
1) Frequent
2) Systematic
3) Substantial Basis

dependant on the security and its liquidity,

Question 22

If considered a systematic internalizer what must be done?

Answer 22

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

Question 23

What is a dark pool?

Answer 23

A forum to trade securities in a non-displayed nature

Size, direction and identity and not displayed

Question 24

What is the motivation behind dark pools?

Who uses them most commonly?

Answer 24

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

Question 25

How much of trading volume do dark pools make up in: 1) UK 2) US

Answer 25

1) 9% 2) 18%

Question 26

What are criticisms of Dark pools?

Answer 26

No longer reflect price of securities Playing field isn't level for smaller investors

Question 27

What has the SEC done to address dark pool criticisms

Answer 27

Launched biggest trading rule overhauls - aim is to level the playing field ## Footnote announced 2022 - undergoing implementation

Question 28

What are the three types of Dark Pool

Answer 28

1) Broker-Dealer owned 2) Exchange Owned 3) Electronic Market Makers

Question 29

What is a broker-dealer-owned dark pool?

Answer 29

Set up by broker-dealers: (usually IBs) Own traders as well as clients use them

Question 30

What is an exchange owned dark pool?

Answer 30

Ran by an exchange - act as agents and not principals

Question 31

What is an Electronic Market Maker Dark Pool?

Answer 31

Independant dark pools - usually offer lower transaction costs (can operate as principals)

Question 32

How are assets priced on Dark Pools?

Answer 32

Mid Point ## Footnote Spreads differ from public exchanges

Question 33

Give 4 Advantages of Dark Pools

Answer 33

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

Question 34

Give 5 disadvantages of dark pools?

Answer 34

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

Question 35

Give two ways in which dark pools differ from traditional markets ## Footnote Broadstrokes, they operate very similarly

Answer 35

1) Liquidity is hidden (no need for iceberg orders) 2) Do not need to provide data to markets

Question 36

What is the impact on markets of dark pools?

Answer 36

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

Question 37

Give two controversies surrounding Dark Pools

Answer 37

1) Lack of regulation 2) HFTs can use predatory practices to front run

Question 38

How has the US regulated dark pools?

Answer 38

SEC & FINRA made more information from dark pools available to public Fined banks for misleading practices

Question 39

How has the EU regulated dark pools?

Answer 39

Certain names barred from being traded on dark pools 4% of trading in a single stock per dark pool 8% across all dark pools ## Footnote once cap is reached, trading on dark pool is prohibited

Question 40

What is a ping pool?

Answer 40

Same as a dark pool but: - Single counterparty - Brokers can enquire as to who is involved - Transparency & regulation is more opaque ## Footnote Less transparency - causes concern for some participants