Industry Leaders Frown on Dark Pool Trend

Traders Magazine ^ | 06/06/08 | Nina Mehta

[TigerLikesRooster]

Industry Leaders Frown on Dark Pool Trend

June 6, 2008

By Nina Mehta

Morgan Stanley and Goldman Sachs, bucking a growing trend among the operators of dark pools, are vowing to stay pure. The two bulge-bracket shops tell Traders Magazine they have no intention of broadcasting out information about orders in MS Pool and Sigma X, their respective alternative trading systems. They say that occurs when electronic indications of interest are sent to third-party pools.

"Sending indications out is something that removes the dark aspect of a dark pool," said Andrew Silverman, head of electronic trading distribution at Morgan Stanley. He stressed that MS Pool, the broker's dark pool for single stocks, does not send out indications on orders residing in the pool.

Goldman Sachs follows the same policy for Sigma X, the industry's largest dark pool. "If a dark pool is putting out indications or IOIs, that's very much going into a gray area," said Rishi Nangalia, head of product development at Goldman Sachs Electronic Trading. "We're philosophically against those kinds of linkages."

The positions of these firms contrast with those of some dark pool operators. A handful of dark pools allow customers to choose to send out indications based on orders residing in their pools. The indications are typically sent to the trading engines of other dark pools, market venues or liquidity-providing firms. This is done to increase the chance of finding a match.

NYFIX, JPMorgan and BIDS Trading, for example, give users the option of sending out indications or similar messages. The firms say they specify what their liquidity partners can do with that information, and they monitor or track the resulting interactions. Other brokers send out actual indications to human traders. These include ITG's BLOCKalert and Pulse Trading's BlockCross. BNY ConvergEx's VortEx dark pool enables clients to interact with IOIs from about a dozen venues, while its ConvergEx Cross for block orders now lets buyside firms solicit potential contra-side orders from others in that pool.

Besides Morgan Stanley and Goldman, firms that don't send out indications include Credit Suisse, which operates the market's second-largest dark pool, and UBS. Credit Suisse's CrossFinder pool executed 130 million shares per day in May. Goldman's Sigma X executed 151 million shares per day last month. MS Pool's average daily volume for the month was 45 million.

However, Morgan Stanley is hedging its bets when it comes to the changing dark-pool IOI arena. The broker has now created a new, separate dark pool designed specifically for IOIs, called ATS6. Interested clients will be able, on an opt-in basis, to send out electronic indications based on flow they submit to ATS6.

Silverman calls ATS6 a "gray pool," noting that some clients may choose to use it to reveal some information about their flow with the goal of finding liquidity. Morgan Stanley created the pool to be ready if and when customers decide they want to send out IOIs on their flow. The firm settled on doing this in a separate ATS to avoid uncertainty about what happens with orders in MS Pool, Silverman said. He added that Morgan Stanley isn't sure the new pool will produce enough interest to go live.

[TigerLikesRooster]

it would move the price of that stock dramatically, and increase volatility way outside of the normal envelope.

Institutions do not mind going public when volatility is in their favor. Institutions can announce certain big transaction in public when you know doing so would increase value of your stock holding dramatically. However, when going public would trigger unwanted sell-off. they may want to do it in secret in a dark pool.

This may have been going on in the past. However, with sophisticated software backing it up, now its trading volume can markedly increase in volume. There are also more than one such venue. Each does their own transaction and we have essentially one public market and several hidden markets of significant size. They may all set different prices for the same item. Price as market signal lose its function. Market confidence will plummet, because nobody knows exactly what the real price of certain item is. Actually, I suspect this is why they try to get feelers out to other venues(dark or public) to find out what the real price could be.

The long-term consequence would be mistrust of public market. Prices people see in NYSE could be actually a mirage. The public stock market becomes useless.

Besides, being so closed, wouldn't it be easier to conceal certain information from regulators or public?

[ChicagahAl]

“The long-term consequence would be mistrust of public market. Prices people see in NYSE could be actually a mirage. The public stock market becomes useless.”

Yes, quite possibly. However, the public prices wouldn't actually be a mirage, they are still actual retail trades at actual retail prices. But most retail investors are clueless anyway (and I don't say that to be mean-spirited). They simply follow the TV talking heads and newsletter writers, so I doubt that dark pools are on their radar. An intriguing thought would be the possibility that dark pools ultimately replace the public markets, even for retail trades, because they offer a more efficient marketplace and are a good deal for the brokerage firms who operate them.

“Besides, being so closed, wouldn't it be easier to conceal certain information from regulators or public?”

I don't see how that could be, because once the trade is executed it must be reported by the institutional investor to the various agencies based on the laws (SEC, IRS, etc)and to their shareholders. There is no way around that.