Dark Pools: Setting the Record Straight on Operational Transparency

Dark pool transparency is a hotly debated topic. Attend a conference or read an article and you'll most often find a confusing mélange of viewpoints that suggest dark pool operators are less-than forthcoming about their operating models.

Interestingly -- and paradoxically -- much of the confusion over dark pool operational transparency is perpetuated by the operators themselves. In the ever-present quest to attract liquidity, aggressive sales people and sales/traders in highly competitive circumstances are apt to compare their pool operations to those of other operators. The problem is that most operators are not clear on the particular nuances of how other venues work.

In addition, add algorithm providers to the confusion-generating list. Nearly all providers offer a range of algorithms that in one way or another access multiple dark venues. To differentiate their algorithms and address best execution concerns, there is frequent discussion of execution monitoring to avoid venues with "toxic liquidity."

And then there are pundits, trade organizations, industry executives and politicians who each have views on dark pools. These views provide color on dark pools underscored by particular agendas. The views set forth by these individuals and groups vary with respect to the message they are trying to disseminate as well as their knowledge of subject matter.

In short, noise abounds. What is the institutional trader to do?

Refreshingly, we have found that beneath the spin, competition, and agendas that constitute a competitive marketplace, most dark pool operators are both willing and eager to get the word out as to how their venues operate. The reason is straightforward: transparency breeds trust. Trust brings liquidity. Liquidity brings transactions. Transactions bring revenue.

Our views are supported by our work. In our recently released dark pool directory, we extensively interviewed 19 dark pool operators managing approximately 25 different venues constituting some 90% of dark pool transaction volume. The overwhelming majority of these providers were extremely forthcoming in their venue operations including the all-important aspects of:

- Value proposition
- Operating Model
- Constituent Segmentation
- Execution Protocol
- Allocation of Price Improvement
- Management Philosophy

The particular areas they were less forthcoming (though not evasive) were on the topics of anti-gaming and liquidity. This makes a lot of sense.

In regard to anti-gaming methodologies, there is considerable intellectual property around particular anti-gaming measures and providers are reticent to expose their particular approaches and capabilities to the broader market. The rational for this is that the more advanced providers would be providing valuable details to lest sophisticated providers and the later would be highlighting to the world that their methods are, in fact, less sophisticated.

Revealing the liquidity characteristics of a pool, in many ways, is information dissemination. On the one hand, it may be beneficial for attracting like liquidity. On the other, it may compromise some of the benefit of the pool by attracting sophisticated traders that can capitalize on such information.

Amidst the noise and competitive pressure of the market, all-important dark pool information is available. Traders need it. Most operators want traders to have it. Who it is obtained from makes all the difference as to accuracy, independence, clarity, and value.