Dark Pools Refuse To Go Quietly Into That Dark Night

As expected, dark pool operators have responded, getting concerned that after the recent escalation in the Flash trade scandal, they are the next natural target. And what surprise that their only retort, as per this WSJ article, is that they provide liquidity, and make stock trading cheaper. Right down to the generic script. At least they haven't used the mutual assured destruction defense clause quite yet.

Geoffrey Rogow at the Wall Street Journal reports:

Several dark-pool executives told Dow Jones Newswires that Mr. Greifeld's far-reaching proposal would have calamitous effects for retail and institutional traders.

"Undisplayed liquidity adds to execution quality," said Bob Gasser, chief executive of Investment Technology Group Inc., which is credited with creating the first of the modern-day dark pools roughly 20 years ago. "You can come up with all kinds of anecdotes, but the simple fact is, on behalf of all investors, dark liquidity adds to execution."

Other alternative-trading system executives called Mr. Greifeld's stance on the issue opportunistic given lawmakers' recent focus on related issues, and suggested that Nasdaq OMX is acting defensively after losing market share to non-displayed trading venues.

And here is where the prisoner's dilemma gets interesting:

Several dark pool officials also noted that both Nasdaq OMX and NYSE Euronext, which has also been losing market share, maintain non-displayed liquidity pools.

But as the NYSE has publicly disclosed, the SLP - that most questionable of recent NYSE liquidity programs has no advance look characteristics. So Zero Hedge assumes that the dark pool operators, in a preamble to full out exchange war are referring to some else. Zero Hedge would be quite curious to understand what that is, especially since the NYSE has been a vocal opponent of non-displayed liquidity.

Furthermore, as Ray Pellecchia disclosed to Zero Hedge recently, "we're not aware of a way to re-route flash data from another market to the NYSE. To the extent that anyone sees flash data it would be in the context of their being a member of another (non-NYSE) market, and any resulting trades would take place there."

And some more tidbits from the WSJ:

As dark pools have grown -- accounting for more than 7% of all trades in June, according to Rosenblatt Securities -- the SEC has made it clear it is evaluating these alternative trading systems, indicating more regulation is likely.

In interviews with nearly a dozen dark-pool executives, none objected to the SEC's initiative. Dark-pool administrators are willing to provide more transparency and standardize volume reporting, with most even demanding it.

But Mr. Greifeld's letter this week went a step further, calling for the elimination of "market structure policies that do not contribute to public price formation and market transparency." The Nasdaq OMX chief tied dark pools to the issue of flash order types, a trading practice in which stock trades, after being checked against an exchange's order book, are sent to a select group of participants before being routed to other exchanges for filling.


"I understand when there's a duopoly, you want to maintain that, because it's a good business model," said Seth Merrin, founder and CEO of Liquidnet, among the largest independent dark pools. "But it's really detrimental to all the people who invest in pension funds or mutual funds, and people who manage institutional order flow."

As Zero Hedge has demonstrated, there is much confusion over what really occurs within the confines of dark pools. However, as even CEOs of various ECNs are beginning to acknowledge there is a two-tier model within exchanges (either currently or in progression). One can take the argument further by simple arithmetic and realize that within this duopoly system, Goldman is an explicit monopolist. And whether or not it is to the benefit or investors to maintain a monopoly (or even a duopoly) is really an anti-trust question.

Thus, Zero Hedge yet again implores Christine Varney to seriously analyze the implications of a firm such as Goldman Sachs monopolizing order flow not only on open exchanges such as the NYSE but in dark liquidity pools via SIGMA X.