At last week's SIFMA's Market Structure Conference, James Brigagliano, co-acting director, division of trading and markets at the U.S. Securities and Exchange Commission ticked off a list of concerns on his mind. In the coming months, the SEC will be examining a number of issues, including, sponsored access, dark pools and pre-trade order and quote messages.The topic of "sponsored access" came up several times during the conference and led to discussions over whether exchanges or brokers should monitor the activity. Sponsored access occurs when an exchange member provides its customers with electronic access to the exchange using the member firm's market participant identifier or MPID-explained Brigagliano. This can be dedicated access or going through a port on the member' s system, said Brigagliano. While sponsored access preserves the anonymity of the participant, there are risks involved to the trader's broker, exchange, clearing entities, said Brigagliano.
He cited Nasdaq's proposal to establish a standard approach to monitoring sponsored access has sparked a useful debate. He also said SIFMA had filed a letter describing a disaster scenario where a single trader's activity could jeopardize the financial system.
"I believe we have learned that dangerous risk conditions must not be ignored," said Brigagliano, signaling that the SEC will address the Nasdaq proposal urging brokers bare the responsibility for sponsored access and views of commentators in coming months.
Dark pools are also at the top of the SEC's agenda, though the staff has not reached any conclusions, he said. Brigagliano defined dark pools as electronic systems that do not display quotes in the public quote system. He acknowledged that dark pools have increased their percentage share of total trading volume in U.S. stocks last year. While volume increases have leveled off since then, that could be a temporary interlude, he added. The problem that concerns the SEC appears to be the lack of transparency from the dark pools. Brigagliano said there was very little reliable public information, which warrants concern. "Public trade reports don't identify whether a trade was reported by a dark pool or the name of the dark pool," he said. They may overstate their true public volume via double counting or report touched volume - that is executed elsewhere, he noted. (Various market statistics were cited during the conference. One person, citing the analysis of Rosenblatt Securities said dark pool volumes doubled from 4- to-8 percent of total U.S. equity trading volume by the end of 2008, while someone else said it was 15-to 20-percent). "Uniform and reliable trade reporting practices would help provide a level playing field, " said the SEC official. An issue worth discussing is whether their post-trade transparency should be enhanced," he said referring to dark pools.
Another hot topic on the SEC's agenda is pre-trade order messages that are disseminated to participants on their private networks. Most dark pools label their pre-trade messages as indications-of -interest or IOIs. Brigagliano noted that many dark pools transmit the messages to specific participants to notify them they have an order that is automatically executable at the NBBO (national best bid or offer). Both actionable orders and quotes can be responded to within milliseconds. However, Brigagliano said there were "policy implications of actionable order messages." The topic of actionable order message or IOIs came up several times during the conference and led to heated discussions among panelists (I will post a separate story on that!)
Dark pools that send IOIs typically transmit them through private networks which could create potential for private markets to emerge," said Brigagliano. The public doesn't have fair access to such networks. There is also the issue of whether dark pools could impair price discovery and divert order flow from the public exchanges. Reading between the lines, the SEC seemed less concerned about block crossing systems, which that offer significant size discovery, and more concerned about small order systems, which execute the highest volume and are the fastest growing type of dark pool. They attract volume of small orders flow away from public market. "To the extent that desirable order flow is diverted, it could affect the execution quality of orders displayed on public markets," cautioned Brigagliano.
If dark pools continue to attract small order volume, will they harm price discovery on the public markets on which many of them depend? Will they deter limit order posting on the public venues, which is an objective of Reg NMS, and worse, will they lead to more volatility? While the SEC official didn't ring any alarm bells and make it sound like the Commission was ready to act on these issues, they were presented as concerns that will be under scrutiny during the next few months.In the coming months, the SEC will be examining sponsored access, dark pools and pre-trade order and quote messages, according to James Brigagliano, the SEC's co-acting director, division of trading and markets. 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