MiFID II: The Impact of Double Volume Cap Mechanism on Market Quality

Abstract

I provide a comprehensive evaluation of the Double Volume Cap mechanism, a regulation that regularly triggers dark trading suspension based on a stock's historical dark trading activity. By analysing the impact of each suspension wave occurring between 2018 and 2020, I show that, during the pre-COVID-19 pandemic period, the dark trading suspension improves market liquidity, worsens informational efficiency, and reduces return volatility, whereas, during the post-COVID-19 pandemic period, the suspension imposes exactly opposite effects on market quality. I also find that lifting the dark trading suspension induces exactly opposite impacts, with a larger effect size, compared to triggering suspension, providing more statistically powerful evidence of how dark trading affects market quality. These results imply that the Double Volume Cap mechanism may have brought about many unintended consequences to the market when the market needs liquidity and stability the most and when the suspension is relaxed. Nevertheless, I do identify evidence that the market gradually learns and adapts to the new trading environment as market participants reduce their reliance on dark pools over time, a result consistent with the policymaker's original objective.

Keywords: COVID-19; Dark Trading; Double Volume Caps; Liquidity; Price Efficiency; Market Volatility; MiFID II

JEL Classification: G10, G14, G19, G28