Hip4Life wrote: Dark pools have a scary name, and to
criticsthey’re scary places: private stock markets housed inside some of Wall Street’s biggest banks. Created to let big investors swap large blocks of shares in secret, they’ve expanded to become a significant part of daily stock trading. More shares now change hands in dark pools
than on the New York Stock Exchange. Dark pools have helped bring down trading costs. But whether markets as a whole suffer when too much trading information is private is something regulators around the world are trying to figure out — along with whether some dark pools have been taking advantage of the darkness to favor some customers over others.
The Situation Rules to limit dark pool trading have been put in place by
Canada and
Australia, and the European Union is phasing in similar measures as part of a comprehensive set of rule changes known as
MiFID II.As a result, firms are
introducing alternativesto keep stock trades under the radar for European traders. The U.S. Securities and Exchange Commission is developing new regulations to increase disclosures about dark pool trades. Last December, the agency and New York Attorney General Eric Schneiderman reached a settlement with Deutsche Bank AG in which it admitted to misleading customers about how its dark pool worked and
agreed to pay $37 million. Earlier that year, Barclays and Credit Suisse agreed to
pay$154.3 million to the same regulators for alleged wrongdoing in their own pools. The settlements were the latest in a string of cases that gave ammunition to critics who said some dark pools were designed in a way that let high-frequency traders place bets knowing which way the market was about to go. That charge had been given prominence in Michael Lewis’s 2014 book, “Flash Boys.” The U.S. stock market has fragmented into 12 public exchanges and roughly 45 alternative trading systems, most of them dark pools.
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Source: Bloomberg
The Background Bonds, currencies and most other financial instruments are generally not traded on open exchanges, and there’s always been some non-public trading in the stock market. Old hands reminisce about “upstairs trading,” a euphemism for private, large-order deals. That was the exception: Since the SEC was formed in the wake of the stock market scandals that led to the panic of 1929, the agency has equated openness with fairness. Publicly shared bids and offers mean a level playing field, and the rapid sharing of price information is seen as central to the market’s role in the efficient allocation of capital. Dark pools arose in the
1980s, when the SEC allowed brokers to bring together buyers and sellers of big blocks of shares. Their recent growth has been driven by electronic trading and a SEC rule meant to spur competition and cut transaction costs that took
effect in 2007. Dark pools can charge lower fees than exchanges because they are usually just one unit in a larger firm. (Not all the operators of alternative trading systems are banks: Bloomberg LP, the parent of Bloomberg News, owns one, Bloomberg
Tradebook, which is registered with the SEC.) Along the way, their client base changed. Dark pools are not generally venues for big orders anymore — one study found that the average order size is now just
200 shares.
The Argument Proponents of traditional exchanges say the secrecy surrounding dark pools leaves the door open to abuses, as there’s no way to know if some clients are getting favored treatment or if brokers are putting their own interests first. The recent settlements have underscored
that idea. Defenders of dark pools have argued that their venues are in general safer from that kind of front-running, and that all investors benefit from competition that has driven down trading costs. The industry has also been opening up: One of its regulators now publishes
ATS trading dataeach week and venue operators are providing customers with more information. As for the pools’ effect on markets, researchers are divided: While some say that price discovery
doesn’t suffer from dark trading, others say that
it does. Former SEC Chair Mary Jo White
waded into the controversyin 2014, saying that consensus of research is that “the current extent of dark trading can sometimes detract from market quality.” The pools’ supporters say the NYSE’s offer to cut fees is proof of how much money the alternative trading systems have saved traders large and small. It’s possible the prospect of more regulation will steer the pools back to their original mission: Average trade size
doubled in European pools even before new rules took effect.