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Exposing the Identity of Dark Pools in Real Time Could Hurt Institutional Traders

Will an SEC proposal to identify dark pools in real-time trade reports do more harm than good?

The SEC points out in its proposal that it wants to close the information gap between dark pools/ATSs and exchanges, whose trade reports specify the name of the exchange where the execution took place. "The commission would like to see ATSs identify who they are and do some type of post-trade reporting," says Brian Hyndman, SVP of transaction services at Nasdaq OMX.

The regulator has cited the growing share of liquidity in NMS stocks claimed by dark pools as a driver behind its efforts to shed light on their operations. While the SEC's proposal said dark pools collectively accounted for 7.2 percent of average daily volume at the end of the second quarter of 2009, Rosenblatt Securities reported that the share of consolidated U.S. equity volume on the dark pools that it tracks jumped from 7.82 percent in June to 10.15 percent in December 2009.

As the number of active dark pools has grown from 10 in 2002 to 29 in 2009, the dearth of information on their trading activity has become a growing concern for many industry participants. "Today there is no 'gold source,' " says Nasdaq OMX's Hyndman. "And a lot of firms want to report -- they want to boast that they have dark pool volume."

Reporting Alternatives

Few, if any, dark pool operators, however, want to report in real time, as the SEC has proposed. According to Credit Suisse's Galinov, for example, the firm prefers proposals from the New York Stock Exchange and Nasdaq to report dark pools' aggregated volumes at the end of day on their TRFs and on their individual Web sites.

To provide transparency into dark pool volumes, in late October 2009 NYSE Euronext revealed a plan to publish dark pool trades through the FINRA/NYSE TRF. In teaming with five of the largest operators of dark pools -- Barclays Capital, Getco, Goldman Sachs Group, Knight Capital Group and UBS AG, which accounted for 4.5 percent of the volume at that time -- NYSE Euronext planned to provide an end-of-day breakdown of volume segmented by executing venue/dark pool, notes Ray Pellecchia, managing director and NYSE spokesman. "The idea was to show the market essentially where all the trades printed on our trade reporting facility took place," he explains.

Nasdaq came out the following day with a similar plan, but both efforts currently are held up while a FINRA filing awaits SEC approval. Both exchanges said they would post the dark pool volumes on their Web sites, so the information would be free to the public.

"The dark pools don't necessarily want to report in real time," says Nasdaq OMX's Hyndman, who adds that Nasdaq would be content with some type of end-of-day reporting. According to the FINRA filing with the SEC, dark pools would voluntarily opt-in, agreeing to identify their trades. "It's likely to be more of an aggregated number, though it may evolve into something that's more granular," Hyndman predicts.

But Credit Suisse feels that end-of-day reporting is not appropriate for highly illiquid stocks in which it takes an institution three or four days to acquire a position. "We feel that [for] small cap stocks, even end-of-day disclosure would be too much information leakage," explains the firm's Galinov, who says he favors end-of-week reporting for small cap stocks.

In addition to concerns regarding the timing of trade reports, some industry participants believe the reporting should be anonymous. Baruch's Donefer suggests that rather than report ATS trades as simply "OTC," perhaps it would be better to indicate on the ticker that the trade occurred in a dark pool. He acknowledges, however, that there is a need for greater transparency.

"There is some value to publically disclosing where the trading is taking place," Donefer says, noting that it would help institutions fine-tune their smart routers in terms of where to look for liquidity. "The downside,' he cautions, "is that, if people see dark pools are trading more shares, they may send more order flow there and end up further amplifying the amount of trading going away from other ATSs and exchanges."

Worried about information leakage, PineBridge's Weinberg supports the view that trade reports should be anonymous, but he agrees that they should reveal that the venue is a dark pool without disclosing the identity of the specific venue. "It doesn't matter which dark pool it is per se, but more that it's trading in the dark," says Weinberg. He points out that most asset managers are currently using dark pool aggregators to get exposure to the various dark pools, and as such, they don't need to see if a stock is active in particular dark pool because the smart order router/aggregator will find it.

Still, others are pushing for full transparency into dark pools. Waddell & Read Asset Management's Albright wants to see trades executed in dark pools reported in the consolidated tape alongside trades executed on lit venues. "My purpose in using a dark pool is to access the liquidity of the dark pool," he says. "Once your trade is done, why not display your trade on the tape?"

There also are different opinions on the Street as to whether dark pools should break down their volume stock by stock or report the total shares traded as aggregated volumes. The SEC specifically has asked industry participants to comment on this point.

In a comment letter released Feb. 23, ITG rejects the view that the ATS should report all of the execution reports for a particular stock on an aggregated basis (i.e., one figure showing the total volume of shares executed in a particular stock on that ATS). "We strongly assert that this disclosure should be furnished on a disaggregated basis -- i.e. trade by trade -- and with no exemption for block executions in order to provide the marketplace with the maximum amount of information," the company stated. "ITG would also recommend that this post-trade reporting requirement be extended to all participants who effect executions, not just ATSs."

For Regulators' Eyes Only

While the SEC is expected to rule on dark pool trade reporting sometime this spring, Baruch's Donefer raises an interesting possibility: real-time reporting to regulators but delayed reporting to the market. "The data should be collected for any trade in every stock and should be available to the regulators in real time but not disclosed publically until the end of the day," he contends.

Credit Suisse's Galinov says his firm doesn't mind disclosing the information to the regulator in real time. "We're not worried about displaying the information to the regulators in real time so they can run their tests," he relates. "What people have problems with is publishing real-time stock information to the overall market. The gamers can be low frequency or high frequency -- it's just the intent."

Baruch's Donefer notes that while the SEC proposal is intended to increase transparency into dark pools, it's also intended to standardize dark pool reporting practices. In addition to the TRFs, most of the major dark pools and ATSs report their trades to TABB Group, the financial market advisory firm, and to Rosenblatt Securities, the institutional agency broker. These firms adjust the data for double counting and analyze the dark pools' market share.

But Nasdaq's Hyndman suggests that more formal reporting would benefit the market. "If the data came from the exchange TRF," he says, "everybody would know that's the gold source."

Ivy is Editor-at-Large for Advanced Trading and Wall Street & Technology. Ivy is responsible for writing in-depth feature articles, daily blogs and news articles with a focus on automated trading in the capital markets. As an industry expert, Ivy has reported on a myriad ... View Full Bio

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