Only The Shadow Knows



A few days ago we shared pointed out an article in Institutional Investor –  Shining More Light on Dark Pools, which highlighted the increased amount of trading in the dark, as well as the rise of Barclay’s  dark pool after a revamp. We asked many questions about how those pools work, and the transparency issues at play.

If your dark pools allow you to choose your contra sides with vivid and complex tools, are they also allowing their high frequency market makers to similarly weed out interaction with you?  As you trade and try to accumulate positions for your portfolio managers, and park resting orders with aggressive limits, how are those dark pools characterizing you? Are you aggressive? Is your order flow deemed too aggressive to match with contra sides you want to be matching with? Are you aware that you may be weeded out? Is data about your activity or profile being shared? Is the process of pick-and-choose matching fair and equitable? Is it disclosed to everybody? Does your dark pool pay rebates to high frequency trading market makers for adding liquidity to their pool? Can those market makers weed you out if they want to just play rebate capture, thereby minimizing chances of adverse selection? Are the same systems and plumbing evolution that have damaged the public lit markets now taking place in the dark markets? While order types and matching logic has to be regulated on exchanges, and are subject to some level of transparency, is the same true for matching logic and order types within dark pools?

The New York Times’ Nathaniel Popper wrote an excellent article in yesterday’s Business Section that also discussed the increased trading off of the public exchanges. Titled As Market Heats Up, Trading Slips Into Shadows, it highlights the worry that this trend is causing for regulators and institutional investors alike, as curiously the trend bucks the efforts of regulators to force more disclosure and less opacity onto Wall Street. The article is most worthy of your time, and this morning we tease with a few snippets:

Investors also have said that they have moved more of their trading into the dark because they have grown more distrustful of the big exchanges like the N.Y.S.E. and the Nasdaq.

The biggest factor pushing trading away from the public exchanges is the ongoing decline in volatility in stock prices, traders say.

Regulators and long-term investors fear that the movement away from exchanges will diminish part of what has made the American stock market the envy of the world: the public auction process.

Australia introduced new rules to limit trading off-exchange, following the lead of Canada, which put regulations in place last fall. In the United States, the Securities and Exchange Commission has so far declined to act.

“We’ve seen some problematic activity when we’ve looked at” dark pools in trading exams, said Mr. Gira, Finra’s head of market regulation. Among long-term investors, 67 percent said that they have “trust issues” with dark pools, according to a survey last year by the Tabb Group.

The article closes appropriately with the perspective of  Invesco’s Kevin Cronin – a leader and investor voice that should be familiar to all of you, as he has been championing investor causes in the media and in Washington for the better part of four years now:

Kevin Cronin, the top trader at the mutual fund provider Invesco, said that to buy and sell stocks in his firm’s mutual funds he has to dedicate an increasing amount of time and money navigating the dark pools. But Mr. Cronin said that he worries as he and other traders escalate the amount of business they are doing out of the public eye.

“It’s just not an efficient market if a fair amount of orders never see the light of day,” he said. “We should all be concerned about this.”