Trading Dip Fuels Speculation Barclays May Shutter Dark Pool

Jul 22, 2014 6:31 am ET

(Updates with comment from Credit Suisse CEO in sixth paragraph.)

July 22 (Bloomberg) -- A drop in trading at the Barclays Plc dark pool being probed by U.S. prosecutors is fueling speculation Chief Executive Officer Antony Jenkins will shut it.

The number of U.S. shares traded on Barclays’s dark pool decreased 79 percent to 66 million in the two weeks through July 6, according to data from the Financial Industry Regulatory Authority. The decline in the second week was the biggest drop among 42 dark pools, the data show.

New York Attorney General Eric Schneiderman said in a complaint filed June 25 that Britain’s second-largest bank lied to customers and masked the role of high-frequency traders to boost revenue of its dark pool. That’s prompted at least four money managers and brokers to pull their business.

“It may be one of those situations where the market decides whether this venue is going to stay open or not,” Richard Payne, a professor of finance at Cass Business School in London, said in an interview. “They will have had that discussion” about closing it.

The dark pool, known as Barclays LX, dropped from second- largest U.S. operator behind Credit Suisse Group AG to 12th last week, the Finra data show. Credit Suisse, which remains No. 1, saw a 19 percent decrease in trading volume that week, with Morgan Stanley, Liquidnet Holdings Inc. and Foliofn Investments Inc. among five U.S. dark pools with an increase.

System Abuses

Credit Suisse CEO Brady Dougan said he remains confident in private trading venues.

“A lot of the electronic trading systems are actually very good for the market,” Dougan told Bloomberg Television’s Manus Cranny in an interview today. “Clearly there have been abuses to the system. We’ve actually worked hard to assure that these abuses are actually driven out of the system.”

Switzerland’s second-largest bank is working “closely with regulators” to make sure the market is “structured in a way that provides a fair playing field for everybody,” Dougan added. Credit Suisse makes about $30 million in annual revenue from its Crossfinder dark pool.

Barclays declined to comment about the decrease in trading or its plans for the dark pool. The bank hasn’t discussed whether to close it, according to a person briefed on the discussions who asked not to be identified because they weren’t authorized to speak publicly.

‘Significant Drop’

Some firms began shunning Barclays’s dark pool after Schneiderman’s complaint. Voya Financial Inc. stopped sending orders to the LX venue, as did Sanford C. Bernstein & Co., Deutsche Bank AG and Royal Bank of Canada, according to people with knowledge of the matter.

While the impact of lower trading volumes at the dark pool is unlikely to show on revenue when Barclays reports its second- quarter earnings on July 30, the bank may report a “significant drop” in the following three months, according to Mike Trippitt, an analyst at Numis Securities Ltd. in London.

Internal documents show that Barclays estimated the value of expanding LX into a leading dark pool to be $37 million to $50 million a year, according to the complaint. By comparison, the bank made 2.6 billion pounds ($4.4 billion) in revenue at its equities and prime services business last year.

Settlement Likely?

Schneiderman’s allegations mark a setback in Jenkins’s efforts to break with the rate-rigging scandal. The 53-year-old took over in August 2012 following Robert Diamond’s resignation in the wake of a 290 million-pound fine for rigging the London interbank offered rate.

In a memo to staff on June 26, Jenkins said that he won’t “tolerate any circumstances in which our clients are lied to or misled.” Barclays has said it’s cooperating with Schneiderman’s office and is examining the matter internally. The lender has until July 25 to respond to his complaint.

“It’s quite likely they will look to settle and then close it down,” said Niki Beattie, a former head of Europe, Middle East and Africa market structure at Merrill Lynch who now runs consulting firm Market Structure Partners Ltd. in London.

Barclays acquired the alternative trading venue in September 2008 as part of its acquisition of Lehman Brothers Holdings Inc.’s New York-based operations amid the darkest weeks of the banking crisis. The dark pool, first opened to customers in 2007 as Lehman Brothers Liquidity Cross, or LX, is an electronic venue for the anonymous trading of stock.

‘Toxic’ Traders

The exchange uses computer algorithms to match buyers and sellers anonymously until after a trade has been completed. This gives institutions the ability to trade large blocks of stock without exposing their position to the open market.

Starting in 2011, Barclays hoarded orders for stocks and assured investors they were protected from high-frequency firms, while simultaneously aiding predatory tactics, Schneiderman said. Expanding its dark pool was a “principal goal” of Barclays’s equities electronic trading division and “central to driving profits,” according to the complaint.

Barclays, while aware of “toxic” high-frequency traders using the venue, encouraged customers its dark pool was a safe place, Schneiderman said.

The bank is being sued under the Martin Act, a piece of 1921 legislation in New York that doesn’t require prosecutors to prove intent to defraud a victim. The state is seeking unspecified damages, disgorgement and restitution.

‘Intense Scrutiny’

Responding to the alleged misconduct, Jenkins temporarily removed Bill White from his role overseeing electronic equities trading last month to focus on the bank’s response to the lawsuit, according to a person briefed on the matter. White isn’t being suspended, the person said.

Under White, the dark pool moved from the fifth-largest in the U.S. in 2011 to second after Credit Suisse three years later, according to data compiled by Rosenblatt Securities Inc.

“Their model will be working better than others over time as they would have gone through intense scrutiny,” said Chintan Joshi, an analyst at Nomura in London with a buy rating on the stock. “In 18 months, there is a good chance that you could see Barclays emerging as a top dark-pool player again.”

--With assistance from Sam Mamudi in New York and Elena Logutenkova and Jeffrey Vögeli in Zurich.