Yesterday, SmartPool said that its dark liquidity pool created by NYSE Euronext with partners HSBC, J.P. Morgan and BNP Paribas, would expand into trading mid-cap securities by September. I caught up with Lee Hodgkinson, CEO of SmartPool, to understand the significance of this new development, recent volume trends and other items on his agenda.

Until this point, SmartPool’s focus has been on Europeans blue chip securities, but now it’s beginning to move into European mid-caps, where the liquidity is scarce and completing larger transactions is more complex, said Hodgkinson, in the interview. “This is where the value proposition of dark trading gets more attractive,”said Hodgkinson.

By heading into mid-cap territory, SmartPool will attempt to differentiate itself from a number of multilateral trading facilities (MTFs) that have launched under the EU’s Markets In Financial Instruments Directive (MiFID). Most of the MTFs in Europe have focused on blue chips, except for one or two that trade mid-caps, including NYFIX Euro Millennium and Plus Markets, noted Hodgkinson.

As an exchange operator, NYSE Euronext is positioning SmartPool as a neutral dark liquidity pool. “Because we’re not a brokerage, and we don’t have any conflicts of interest, we’re not trying to internalize customers’ business and match against our proprietary books. We’re just operating an impartial, execution service,” he said.

While NYSE Euronext owns four European equity exchanges – Amsterdam, Brussels, Lisbon and Paris — none of the new stocks that it’s adding are trading on NYSE Euronext. “This is an expansion into the other markets in Europe,” said Hodgkinson, since under the MiFID regulation.

One of the main characteristics of dark trading is that if offers anonymity to institutions and the ability to execute block or bulk transactions, with the potential for reduced market impact at improved execution prices, according to SmartPool’s CEO. Unlike the lit markets where the average trade size is 8,500 Euros, executions on Smart Pool are running four-to-five times that size. And SmartPool’s mid-point matching service offers anywhere between three and seven basis points of price improvement, Hodgkinson added. However, as it expands into mid-cap securities where the spreads are wider, the price improvement should be even greater, he said.

SmartPool is also looking to capitalize on the strength of NYSE Euronext’s family of exchanges, which have access to a broad base of customer community, not just in London, but across Europe as well. “And that’s something that the other MTFs haven’t got,” asserted Hodgkinson.

While recognizing that the big investment banks in London are critical to the success of the MTFs, Hodgkinson also noted that having a non-homogenous customer base with different types of flow that can interact with each other is important. “Ultimately all trading is building communities,” he said. SmartPool hopes to leverage the relationships of its established brand. Hodgkinson cited the example of the Amsterdam Stock Exchange, one of the oldest organized exchanges in Europe, which can leverage its deep relationships with brokers to attract order flow, which is easier than having to build a brand from scratch, he said.

Hodgkinson said that NYSE Euronext always had in mind an expansion to Pan European mid-cap securities, but dark trading is still in its infancy in Europe unlike in the U.S. where it is by far advanced, he said. While trading in non-displayed venues accounts for nine-or-ten percent in the U.S., in Europe it accounts for only two-to-three percent. “But the appetite from the customer based is enormous,” said Hodgkinson.

As a sign off that demand, the value of trading activity on the SmartPool platform in Q2 of 2009 increased by 90 percent above Q1’s level, but he declined to cite the exact percentage increase, while August was thinner, given the traditional European vacation season. Hodgkinson said he is happy with the growth story so far, and is anticipating a return to higher volumes in September when the dark pool is slated to go live with trading in mid-cap Pan-European securities.

Right now, SmartPool is working out the details with partners and service partners to make sure the static data work and clearing firms are prepared and have the correct securities list and are able to process changes to those securities.

SmartPool has arranged that trades for Euronext-listed stocks will clear through LCH.Clearnet and trades for all other European markets will be cleared via EuroCCP. “In these days of heightened concern over counterparty risk, having a long established clearing presence for your clearing is essential,” explained Hodgkinson, noting that EuroCCP is backed by the DTCC.

Looking ahead, NYSE Euronext will be migrating SmartPool’s matching engine to London in November. While SmartPool is a London-based business,the parent company supplies the technology in Paris at the moment. As part of the consolidation of data centers occurring under NYSE Euronext, a new data center is being built in London as well as in New Jersey.