Dark Pools Fire Back at Call for Ban

NEW YORK – Dark-pool operators are firing back at the chief executive of Nasdaq OMX Group Inc., arguing that banning their platforms would make buying and selling stocks more expensive for all investors.

This week Nasdaq CEO Bob Greifeld called for regulators to end all forms of "dark liquidity," ratcheting up the dialogue around the role of alternative- trading systems and off-exchange liquidity in U.S. cash markets.

Dark pools, a fast-growing form of alternative trading, are electronic-trading venues where money managers trade large blocks of shares anonymously.

Several dark-pool executives told Dow Jones Newswires that Mr. Greifeld's far-reaching proposal would have calamitous effects for retail and institutional traders.

"Undisplayed liquidity adds to execution quality," said Bob Gasser, chief executive of Investment Technology Group Inc., which is credited with creating the first of the modern-day dark pools roughly 20 years ago. "You can come up with all kinds of anecdotes, but the simple fact is, on behalf of all investors, dark liquidity adds to execution."

Other alternative-trading system executives called Mr. Greifeld's stance on the issue opportunistic given lawmakers' recent focus on related issues, and suggested that Nasdaq OMX is acting defensively after losing market share to non-displayed trading venues.

Several dark pool officials also noted that both Nasdaq OMX and NYSE Euronext, which has also been losing market share, maintain non-displayed liquidity pools.

As dark pools have grown -- accounting for more than 7% of all trades in June, according to Rosenblatt Securities -- the SEC has made it clear it is evaluating these alternative trading systems, indicating more regulation is likely.

In interviews with nearly a dozen dark-pool executives, none objected to the SEC's initiative. Dark-pool administrators are willing to provide more transparency and standardize volume reporting, with most even demanding it.

But Mr. Greifeld's letter this week went a step further, calling for the elimination of "market structure policies that do not contribute to public price formation and market transparency." The Nasdaq OMX chief tied dark pools to the issue of flash order types, a trading practice in which stock trades, after being checked against an exchange's order book, are sent to a select group of participants before being routed to other exchanges for filling.

Critics allege this gives such participants, sometimes including those that use dark pools, an unfair information advantage. Sen. Charles Schumer (D., N.Y.), last week told the SEC in a letter he will move to limit flash orders if the commission doesn't.

Nasdaq OMX adopted the practice with a nod toward competitive pressure from rivals BATS Exchange and Direct Edge, which have their own versions of flash orders. However, BATS and Nasdaq OMX have both voiced support for banning the practice in recent days.

The issue for dark pools is more complex. Unlike flash orders, retail investors use dark pools and benefit from them, proponents say.

Mutual funds, for example, receive cash from individuals, endowments, pensions and others, and then go to the market with one large pool of money. If they revealed a massive order to the displayed market, it would drive prices higher and make it more costly to invest.

Also, day traders with accounts through market providers such as E*Trade Financial Corp. or TD Ameritrade Holding Corp. go through brokers to find the national best bid and offer, or NBBO, which is often in dark pools. Operators of the platforms said Mr. Greifeld's comments overlook factors such as these.

"I understand when there's a duopoly, you want to maintain that, because it's a good business model," said Seth Merrin, founder and CEO of Liquidnet, among the largest independent dark pools. "But it's really detrimental to all the people who invest in pension funds or mutual funds, and people who manage institutional order flow."

The rise of dark pools

Attack of the clones

Jul 2nd 2009
From The Economist print edition

New trading venues offer a challenge to conventional exchanges

THERE is more than a hint of science fiction in the new jargon of finance. Systemic councils are being formed all over the place. America has appointed a “special master” to look at pay practices in bailed-out firms. And in the world of exchanges, “dark pools” are rising fast.

Dark pools are trading venues that match buyers and sellers anonymously. By concealing their identity, as well as the number of shares bought or sold, dark pools help institutional investors avoid price movements as the wider market reacts to their trades.

Most dark pools are operated by electronic exchanges and broker-dealers. As conventional exchanges increasingly handle small, frequently traded orders, dark pools have become the preferred venue for large “block” transactions. In America more than 40 dark pools are in operation, accounting for an estimated 9% of traded equities. The EU’s introduction of the Markets in Financial Instruments Directive (MiFID), a framework for financial services that provides for off-exchange trading, is sparking similar growth in Europe (see chart). On June 29th BATS Europe, an upstart electronic exchange with American roots, announced plans to offer dark-pool trading from next month.

The swell of dark pools raises questions for investors, regulators and exchanges. For investors, too many new trading venues may cause liquidity to fragment. Turquoise, a European dark-pool operator owned by a consortium of investment banks, will launch an aggregator on July 20th to scour the dark pools of nine broker-dealers including Citibank, Deutsche Bank and Merrill Lynch in an attempt to offer investors better pricing and a higher rate of matching trades. The market will also do its bit. Although dark pools have captured a significant chunk of equity-trading volumes, many are still struggling to turn a profit. “I have no doubt there will be downward pressure on the total number of dark pools,” says Marcus Hooper of Pipeline, another operator, who reckons consolidation will go furthest in Europe.

Regulators voice two contrasting concerns. One is that some dark pools give off signals, or indicators of interest, about positions that others can exploit. Backers say the pools are designed to reduce the ability of investors to front-run large orders. The other is that they hamper price discovery. Mary Schapiro, the chairman of the Securities and Exchange Commission, has expressed concern about their opacity. Immediate disclosure of orders, after they have been executed, is the obvious answer.

Conventional exchanges are already struggling with lower trading volumes and a meagre flow of public share offerings, both side-effects of the recession. They can ill afford to lose more business to dark pools. Some incumbents are taking the fight directly to the upstarts: the London Stock Exchange, one of the world’s oldest bourses, announced on June 29th that it had received regulatory approval for the launch of Baikal, its own pan-European dark pool. Yoda would approve.

Exchange-backed dark pool in the offing by 2010

Business Times - 13 Aug 2009

SGX ties up with Chi-X to cross block trades in region for the big boys

By CHEW XIANG

(SINGAPORE) The Singapore Exchange (SGX) has joined hands with Chi-X to set up the region's first exchange-backed dark pool by mid-2010. The 50-50 joint venture will anonymously cross block trades of Singapore, Hong Kong, Japan and Australia-listed stocks for big funds and institutional investors.

Trades will be cleared through a pan-Asian central counterparty to be appointed, Chi-X and SGX said at a joint press conference yesterday. New York- headquartered Chi-X provides electronic trading platforms worldwide and a subsidiary will supply the technology for the planned dark pool.

'We expect and hope that it will improve overall trading liquidity here,' said Gan Seow Ann, senior executive vice-president and head of markets at SGX. The planned venture could be the fourth exchange-led dark pool set up, after NYSE Euronext's SmartPool, Nasdaq OMX's Neuro Dark and the London Stock Exchange's Baikal.

Incoming SGX CEO Magnus Bocker is now serving out his contract as president of Nasdaq OMX and is 'aware' of the Chi-X deal, said Mr Gan.

Dark pools, as the name suggests, provide a way to discreetly match large-volume orders without moving the market - making possible trades that previously would not have been crossed.

But they still rely on traditional exchanges for reference prices and there is concern, especially in Europe and the US, that markets will fragment as more trades take place in such anonymous venues, eroding the price discovery function of primary exchanges.

The joint venture between SGX and Chi-X is seen as a pre-emptive move. SGX's planned dark pool will act as an 'aggregator' linking broker-led dark pools as well as traditional brokerages, said Chi-X Global chairman Tony Mackay.

Two dark pools - Liquidnet, which focuses on buy-side clients, and CLSA-backed BlocSec - are already active in Singapore, and brokerages such as UBS are keen to introduce internal dark pools here as well. Dark pools already in Asia include those run by Goldman Sachs, Credit Suisse, UBS, Investment Technology Group and Instinet, which is Chi-X's parent company.

An exchange-backed dark pool would 'legitimise what we've been trying to do here to build up the market', said Greg Henry, head of Liquidnet in Singapore.

The pan-Asian dark pool will also complement Chi-X's efforts to introduce its alternative exchange systems throughout Asia, said Mr Mackay. These are essentially high-speed, low- cost electronic exchanges that in Europe have captured 15 per cent of trading in equities listed there, according to a June report from Aite Group. Chi-X is a market leader in such multilateral trading facilities there.

Chi-X was keen on setting up a similar alternative exchange in Singapore, according to a BT report last November. It has also applied, along with Liquidnet and AXE-ECN, a unit of the New Zealand Stock Exchange, to set up alternative exchanges in Australia. But the applications there have stalled as the Australian government has yet to grant market licences.

Such an exchange if approved in Singapore would have competed directly with SGX for trading fees but the two parties appear to have agreed to work together instead. Negotiations began at the start of the year, said John Lowrey, CEO of Chi-X Global.

Mr Lowrey said an exchange-backed dark pool would give it the size and the neutrality required to aggregate liquidity, and would also not hurt price discovery. 'I don't see dark pools dominating in terms of price formation,' he said yesterday.

Some fear that dark pools would also create an unequal playing field for investors but Chew Sutat, executive vice-president and head of market development at SGX, said the dark pool would not marginalise small investors. They could still access the primary market and should also benefit from increased liquidity in the system, he said.

The planned dark pool will apply for a recognised market operator licence here, Mr Lowrey said, and will get the necessary regulatory approvals in Australia, Hong Kong and Japan. 'Our experience has shown that users are looking for independent, genuinely neutral dark pools,' he said.