Cover Story: End of the Line?
SEC Targets Dark Pools and Off-Board Trading
Traders Magazine, September 2009
Has the era of the dark pool come to an end? The Securities and Exchange Commission, spurred on by concern about two-tiered markets as well as criticism that it is not doing enough to level the playing field for ordinary investors, is expected to propose new rules this fall that could reduce the amount of trading done away from the public markets.
Mary Schapiro, SEC
Sources tell Traders Magazine they believe the SEC will issue both an outright rule proposal as well as a "concept release" outlining possible changes to the way broker-dealers operate their dark pools. The SEC's concern is that too much volume is being done away from exchanges and electronic communication networks, and within the four walls of individual broker-dealers. That could hurt price discovery. In addition, allowing that to happen is seen, by some, as bad public policy because it short-changes those traders placing limit orders in the public markets and could hamper investors seeking the best available prices.
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Currently, about 22 percent of all share volume is done off-board, including volume executed in dark pools. Whether that figure is too high for the SEC is not known. Any new rule proposal or concept release is likely to kick off a debate about how much volume, and what kind of volume, can acceptably be done away from the displayed markets without impacting price discovery.
"The jury is out--very much, I think--on dark pools," SEC Chairman Mary Schapiro said on CNBC last month. "That's part of the analysis we're going through now and we'll seek public comment broadly."
Schapiro isn't pulling any punches. In a June speech, she laid out one of the SEC's big concerns: that the "lack of transparency" about where dark pool executions are occurring could "undermine public confidence in the equity markets, particularly if the volume of trading activity in dark pools increases substantially." She also highlighted the "danger that significant private markets may develop that exclude public investors."
What's now on the table is nothing short of a reassessment of key elements in Regulations ATS and NMS. The two biggest changes being considered are a decrease in the 5 percent volume threshold for display obligations and fair access for dark pools, and adjustments to the trade-through rule.
So exactly what might the SEC do? Imagine this scenario unfolding over the course of the next year: The SEC drops the threshold for dark pools to publicly display quotes and provide fair access from 5 percent to, say, 1 or 2 percent. It redefines dark pools, knocking out of commission those that are pure internalization engines for market makers. Automated indications of interest that zip around between dark pools and from dark pools to trading centers or other venues must be publicly quoted if the ATS triggers display requirements. All dark pools must count executions the same way and reveal more information about their trading activity after a suitable time delay, enabling broker-dealers to know how much of the market in particular securities is trading in particular ATSs.
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