December 05, 2006

Each time a new dark book is launched, I can't help but think that one way the industry is preparing for Reg NMS is by avoiding it. Just last month two new consortiums were created — LeveL and BIDS (see story, page 15) — and just a few weeks ago Fidelity Capital Markets launched its new dark ATS, CrossStream. This, of course, comes on the heels of a slew of other new dark books. (Someone mentioned that the number now has reached 40. I don't count that many, but there certainly are more than I can count on two hands.) It strikes me as intriguing that every broker-dealer now is interested in trading in the dark, just months before Reg NMS' new trade-through rule is to be enacted, which only applies to markets that display their liquidity.

Dark books have existed for many years — Liquidnet, which launched in 2001, was one of the first. So why all the fervor now to launch a crossing network? Are broker-dealers really getting in the game simply to automate the crossing of internal order flow that may have been matched manually previously? Is this sincerely a way to better service their buy-side customers who want options for anonymous trading? I wonder.

It seems every buy-side trader I've spoken to is getting more confused by the number of venues entering the market. They're worried about the tools needed to route orders appropriately and truly perform best execution with the fragmentation severing the market today. As Andy Brooks, head trader, T. Rowe Price, said to me, "If everyone goes dark, we'll all be in the dark." Now that can't be a good thing, can it?

Of course, currently the overall volume trading on these venues is relatively small — about 14 percent — and all the dark crossing networks (except Liquidnet) must adhere to volume restrictions (if they trade more than 5 percent of volume in a stock, they have to publish a quote), so there are some safeguards in place. However, with the goal of Reg NMS to create a level playing field and greater transparency, members of the SEC must be scratching their heads, thinking, "More volume moving to dark trading venues is the last thing we anticipated. What should we do now?"

For the most part, Reg NMS has pushed the industry to make quicker decisions and innovate. For example, just last week the NYSE closed one of its five trading floors, and there are reports that the NYSE Hybrid's volume and market share are increasing, signaling a successful transformation to more automated and efficient trading. However, the new regulation also may have created a few new headaches, like figuring out what to do and how (or if) to regulate 40 new marketplaces. Anyone who may be trying to dodge NMS most likely won't be able to do so for long.

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