Dark Pools: A Misunderstood Label
An alternative trading system ("ATS") that does not publish quotes to the marketplace gets the unfortunate moniker "dark pool".
That label leads some in the investing public to believe that nefarious activities are taking place, when in fact dark liquidity has existed in many forms since the beginning of trading on organized stock exchanges.
Indeed, ATSs that do not publish quotes are only one form of "dark" trading that occurs today.
The Securities and Exchange Commission (SEC) is focused on equity market structure, among its many responsibilities.
With various rule proposals,as well as a concept release seeking comments on a wide range of market structure topics, the SEC has sought and received input from many market participants from the smallest of retail investors to the largest pension plans and the tiniest of hedge funds to the grandest of money managers, as well as all manner of broker-dealers and other financial intermediaries.
The SEC is now synthesizing these comments and considering what new regulation, if any, is appropriate.
One of the rule proposals relates to possible changes to the regulation of ATSs that do not publish quotes.
ConvergEx Group's comment letter on this rule proposal can be found on www.
sec.
gov.
The comment letter discusses some of the history of dark liquidity, the reasons it exists, and the purposes it serves.
The letter also takes a candid look at the SEC's proposed rules and tries to suggest some modifications that might help achieve the SEC's goals without hindering this important source of liquidity and best execution.
Hedge funds, both large and small, can utilize dark pools to enhance their trading strategies in several key ways.
First, ATSs provide additional liquidity that may not be available in the published quotes or on exchanges.
Most investors appreciate the anonymity available through ATS trading, so you can find additional liquidity by accessing dark pools.
Second, many ATSs offer price improvement over the published quote.
If every trade you execute is price improved a penny a share, the fund's alpha would show measurable improvement.
Third, large blocks are more likely to trade smoothly and with less market impact when traded in an ATS.
Fourth, the anonymity afforded by dark pools means that a hedge fund can submit orders with little or no market impact.
ATSs with non-public trading interest are just as important to the efficient functioning of the equity markets as exchanges and public quotes.
So be afraid of Darth Vader and the dark side.
But don't avoid the liquidity and price improvement of dark pools.
That label leads some in the investing public to believe that nefarious activities are taking place, when in fact dark liquidity has existed in many forms since the beginning of trading on organized stock exchanges.
Indeed, ATSs that do not publish quotes are only one form of "dark" trading that occurs today.
The Securities and Exchange Commission (SEC) is focused on equity market structure, among its many responsibilities.
With various rule proposals,as well as a concept release seeking comments on a wide range of market structure topics, the SEC has sought and received input from many market participants from the smallest of retail investors to the largest pension plans and the tiniest of hedge funds to the grandest of money managers, as well as all manner of broker-dealers and other financial intermediaries.
The SEC is now synthesizing these comments and considering what new regulation, if any, is appropriate.
One of the rule proposals relates to possible changes to the regulation of ATSs that do not publish quotes.
ConvergEx Group's comment letter on this rule proposal can be found on www.
sec.
gov.
The comment letter discusses some of the history of dark liquidity, the reasons it exists, and the purposes it serves.
The letter also takes a candid look at the SEC's proposed rules and tries to suggest some modifications that might help achieve the SEC's goals without hindering this important source of liquidity and best execution.
Hedge funds, both large and small, can utilize dark pools to enhance their trading strategies in several key ways.
First, ATSs provide additional liquidity that may not be available in the published quotes or on exchanges.
Most investors appreciate the anonymity available through ATS trading, so you can find additional liquidity by accessing dark pools.
Second, many ATSs offer price improvement over the published quote.
If every trade you execute is price improved a penny a share, the fund's alpha would show measurable improvement.
Third, large blocks are more likely to trade smoothly and with less market impact when traded in an ATS.
Fourth, the anonymity afforded by dark pools means that a hedge fund can submit orders with little or no market impact.
ATSs with non-public trading interest are just as important to the efficient functioning of the equity markets as exchanges and public quotes.
So be afraid of Darth Vader and the dark side.
But don't avoid the liquidity and price improvement of dark pools.
Source...