SEC: Dark Pools May Get Lighter

by Glen Shapiro, LawAndTax-News.com, New York

23 October 2009

The Securities and Exchange Commission has issued proposals designed to shed greater light on “dark pools” of liquidity. Dark pools of liquidity are a type of alternative trading system (ATS) that does not display quotations to the public.

The largest dark pools are sponsored by securities firms primarily to execute the orders of their customers and proprietary orders of the firms. The number of active dark pools transacting in stocks that trade on major US stock markets has increased from approximately 10 in 2002 to approximately 29 in 2009. For the second quarter of 2009, the combined trading volume of dark pools was approximately 7.2% of the total share volume in these stocks. Given the growth of dark pools, this lack of transparency could create a two-tiered market that deprives the public of information about stock prices and liquidity.

The SEC's proposals address three specific concerns related to dark pools:

• The first proposal would require actionable Indications of Interest (IOIs) – which are similar to a typical buy or sell quote – to be treated like other quotes and subject to the same disclosure rules.
• The second proposal would lower the trading volume threshold applicable to ATSs for displaying best-priced orders. Currently, if an ATS displays orders to more than one person, it must display its best-priced orders to the public when its trading volume for a stock is 5% or more. The SEC proposal would lower that percentage to 0.25% for ATSs, including dark pools that use actionable IOIs.
• The third proposal would create the same level of post-trade transparency for dark pools – and other ATSs – as for registered exchanges. Specifically, the proposal would amend existing rules to require real-time disclosure of the identity of the dark pool that executed the trade.

Systems are already being developed to allow for this transparency. Beginning November, NYSE Euronext (NYX) will provide a means for participating broker-dealers’ ATSs and off-exchange market centers to report volumes and individual “dark pool” activity by allowing the firms to “print” trades on the FINRA/NYSE Trade Reporting Facility (TRF) and display the daily activity of each trading venue on NYSE.com.

"This initiative is an important step toward the standardization of trade volume reporting across ATS venues," said Frank Troise, Head of Equities Electronic Product at Barclays Capital. "Industry participants will be able to make more informed order placement decisions and thereby improve their execution quality."

The daily trading activity volume published by the FINRA/NYSE TRF will be based on trades reported to the FINRA/NYSE TRF, which follow FINRA’s trade-reporting rules. Basing the published volume strictly on trade reports will address some of the problems associated with voluntary reporting by ATSs of their own volume, such as counting both sides of a trade.

Trades reported to FINRA/NYSE TRF will be single-counted and matched-only. All ATS trades are currently reported to an industry TRF, which in turn drives the various “time and sales” market data feeds. This initiative attributes the volumes to the matching destination. Each trade reporting facility provides a mechanism for the reporting of transactions effected otherwise than on an exchange.

"We should never underestimate or take for granted the wide spectrum of benefits that come from transparency, which plays a vital role in promoting public confidence in the honesty and integrity of financial markets," said SEC Chairman Mary Schapiro. "Today's focus on dark pools is just one part of our broader ongoing review of how the equity markets are structured."

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