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December 1, 2010

IOSCO Targets Dark Pools

By Peter Chapman

The International Organization of Securities Commissions, a think tank for the world's securities industry regulators, is taking aim at dark pools.

Vlad Khandros

IOSCO's influential technical committee last week published a paper that directs its members to consider reining in the practices of dark pools. While acknowledging the benefits of dark pools, the committee identifies a number of potential problems it believes regulators should address.

The Madrid-based body's biggest concern is transparency. The relative lack of both pre-trade and post-trade transparency, when compared with that of public exchanges, could damage the price-discovery process, as well as hamper the search for liquidity, IOSCO wrote.

Heretofore, IOSCO has largely confined its work to the regulation of public exchanges. With the publication of its paper in October, however, it considers extending the transparency requirements of exchanges to dark pools. (In the U.S., dark pools are operated by broker-dealers.)

Specifically, IOSCO is concerned that because dark pools do not publish their quotes, they do not contribute to pre-trade price discovery. That raises the issue of "whether they free-ride on the revealed intentions of other participants in the market," IOSCO wrote.

IOSCO also noted that the lack of quote data means that unless a liquidity seeker has the ability to send indications of interest, the only way to find contra interest is to route an order to a dark pool. This could cause a "possible impact on market efficiency with participants having to ping multiple dark pools," IOSCO said.

IOSCO had a laundry list of ideas for regulators. It suggests they should consider whether or not so-called "actionable IOIs" should be deemed quotations, and therefore displayed. Second, it recommends that regulators consider whether or not the dark pool should be revealed once the trade is consummated. Regulators should decide whether the dark pools should be identified on a real-time or end-of-day basis and whether dark pools should be identified on a trade-by-trade basis or in the aggregate.

Perhaps coincidentally, the U.S. Securities and Exchange Commission last year proposed three rulings dealing with dark pools' use of IOIs and post-trade reporting similar to IOSCO's recommendations. The SEC has yet to rule on these.

While IOSCO deals with the issues facing all 180 of its members, its technical committee focuses on the world's most developed markets. It is considered a standard-setter. In 1999, for instance, the SEC adopted disclosure rules covering foreign private issuers that were developed by IOSCO.

The IOSCO paper could strengthen the hand of U.S. public exchanges that have complained they are not on a level playing field when competing against broker dark pools. Over the past year, exchanges have called for new rules on dark pools and new opportunities for themselves such as sub-penny trading.

At least one exchange official was upbeat after the release of the report. "The IOSCO report is interesting," Bob Greifeld, Nasdaq OMX chief executive, said during a quarterly earnings conference call. "It represents an opportunity for exchanges. IOSCO represents the collective view of securities regulators across the planet."

A dark pool operator, on the other hand, saw potential trouble ahead. "Our biggest concern is that the buyside's ability to source liquidity will be negatively impacted due to potential misconceptions among regulators and policy makers," Vlad Khandros, market structure and public policy analyst at Liquidnet, said about the IOSCO report in a note for clients.

The agency broker does not believe dark pools have adversely affected the price-discovery process. If they had, "we would presumably see a widening of quoted spreads," Khandros said, "and this does not seem to be the case."


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