One problem that people with a lot of time on their hands like to get worked up about is that academic economists sometimes write papers advocating positions that benefit organizations that give them money, while being coy about that relationship. On the other hand this newish paper about dark pools, which compete for stock trading orders with exchanges like NYSE and Nasdaq, has a first author whose affiliation is listed as “The NASDAQ OMX Group, Inc.,” so that’s fine then. Guess what he thinks? No, kidding, you don’t get to guess, he thinks dark pools are bad, duh.
The study, by Dr. Frank Hatheway, Nasdaq OMX Group; Dr. Hui Zheng, the University of Sydney; and Dr. Amy Kwan, the University of New South Wales, looks at US trading venues with restricted access and without displayed orders – generically referred to as “dark pools” – which increasingly segment order flow in the US. … The authors show that the effects of order segmentation by dark venues are damaging overall price discovery and market quality.
I’m a sucker for market microstructure papers because I like the Hobbesian world they imagine, where everyone is trying to rip everyone else’s face off, and keep their own face on, every nanosecond. Read more »
Much success in financial innovation is due to coming up with a sexy name; “dark pool” just grabs the imagination more than “alternative trading system with undisplayed orders.” The downside, though, is that it also seems to have grabbed the SEC’s imagination, which I suspect is part of the explanation for the SEC’s rather odd enforcement action against horribly capitalized eBX, LLC’s horribly capitalized dark pool LeveL.
Here is my effort to understand it:
- eBX is a company that runs a dark pool named LeveL.
- As far as I can tell “runs a dark pool” means (1) wrote a computer program to match buy and sell orders without displaying those orders to anyone else (thus, “dark”) and (2) runs around convincing people to route their orders to that computer program.
- LeveL contracted with Lava to run LeveL’s computer program on Lava’s servers.
- LeveL also contracted with Lava to be the gateway to it.1
- So basically if you wanted to buy a share of GS at $125, that order would go into a Lava router computer, which would then send it to the Lava matching engine computer.
- If there was a GS sell order in the matching engine at $125, you’d buy GS; if not, your order would sit there and wait for a sell order.
- Lava, separately, ran a “smart router” where its clients could submit orders to sell GS at $125, and Lava would route those orders to the exchange that had orders to buy GS at $125.
- Lava convinced LeveL to allow it to “remember” what orders went through the LeveL router, so that when its smart-router clients used the smart router, it could be smart: it routed orders to places that had contra side orders. So if someone placed a sell order on LeveL, and the Lava smart router later got a buy order on the same stock and a matching price, Lava would route the order to LeveL; if there was no such sell order it wouldn’t.
- But LeveL was telling clients that it couldn’t use their orders for any purposes other than matching them; as the SEC’s order says, “most LeveL subscribers were not provided with the additional information that their unexecuted order data was being remembered by the Memory Feature and was being used to make order routing decisions for customers of the Order Routing Business.”
So many questions. First: did this hurt anyone? One thing to think is “if it did, surely the SEC would tell us about it,” and they … sort of didn’t. Robert Khuzami, who still cannot resist a chance to say things like this, said this thing: Read more »
Goldman Sachs, Morgan Stanley and UBS said this morning that they have agreed to share their “dark pools,” the trading arenas used by institutional investors seeking to trade large blocks of stocks without alerting the broader market about such moves. All of the major investment banks operate dark pools, with Goldman Sachs widely thought to be the industry leader.
Dark pools have been criticized as sapping transparency from the market, perhaps making pricing less efficient and certainly creating more uncertainty about the actual volume of shares trading hands. Large trading orders are broken into smaller pieces and matched to other orders by computers. Traditionally this has been done internally within each individual bank. Under the plan announced today, Goldman, UBS and Morgan Stanley will allow for the secretive trading to take place between their clients. The pools are Goldman’s Sigma X, Morgan Stanley’s MS POOL and UBS’s PIN ATS.
The move threatens to take business away from the public stock exchanges and furthers consolidation in the brokerage industry, as the large investment banks with many clients are obviously best positioned to employ dark pools. Dark pools now account for some 10 percent of equities trading in the United States, and more than 20% of all trades in New York Stock Exchange-listed stocks.
Goldman, UBS and Morgan Stanley agree on dark pools [Reuters]