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SEC Takes Dramatic Stance on Dark Pools with Rule Proposal

In an SEC meeting today in Washington, D.C., the regulator proposed a new rule that ultimately aims to move flow out of the dark and into the lit markets.

In an SEC meeting today in Washington, D.C., the regulator proposed a new rule that ultimately aims to move flow out of the dark and into the lit markets. The major changes include:

1. Lowering the volume threshold at which quotes must be made public from 5% of average daily volume in a name trading in a particular venue to .25%.

2. Making dark pools print trades to the tape in real time. They will have to identify who is trading, on what side, where the trade was executed, and how much and at what price, unless the trade is of a value of greater than $200,000.

3. Actionable Indications of Interest would be categorized as quotes, and thus would have to print to the central quoting system. However, the SEC did not define actionable IOIs.

Cheyenne Morgan, analyst TABB Group, attended the meeting and said it was clear that the SEC was taking a dramatic stance against dark liquidity. She further explained that the SEC didn’t lower the volume threshold just slightly to 3% or 4% because the goal is “to force these guys to display their quotes.”

If a trader reaches the 5% threshold today, that trader will set down the name and won’t trade it any more. With a .25% threshold, a trader would reach that threshold so quickly they would be forced to display that quote. Morgan expects significant pushback on this portion of the proposal, especially from the likes of Morgan Stanley and Goldman Sachs.

Regarding dark pools printing to the tape in real time, Morgan believes that real time printing is not necessary. She believes that post trade transparency is needed but it would hurt the market if they had to print on a real-time basis and identify themselves, where the execution happened, how much and at what price.

“This is counter to the purpose of a dark pool. The whole premise of a dark pool is not to see everything. If you see everything, you can use that information to your advantage and understand the person’s trading strategies. This is not advantageous to anyone,” she explains.

Her take on categorizing actionable IOIs as quotes, is problematic because there is no definition for an actionable IOI. She says that the definition of an actionable IOI was left vague intentionally and thus a message including any information including size, price, or amount—will be considered a quote. “The SEC left this open ended so that people can’t easily get around it.” One of the questions that came up was how can the SEC enforce this?

Overall, the SEC needs to be very careful about unintended consequences, Morgan warns. She believes that the SEC did not have a lot of data to back up their proposal and suggests the regulator does more analysis and studies how markets are inter-related before restructuring.

“I do think there needs to be more transparency,” she says. However, the transparency that is needed is post-trade transparency. She explains that there is no standardization of how dark pools report their results. The buy side is not even sure how their orders are being executed, how they are preferenced, etc. There needs to be more transparency with regards to how dark pools interact with each other.”

Her parting words, “The SEC needs to talk to the users of the dark pool, find out how what they do is interrelated with the markets as a whole before imposing regulation that can have very serious unintended consequences. They should also understand the benefits of dark pools so they don’t screw up the good parts.”

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