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January 2, 2014

NYSE Builds A Dark Pool

Tired of seeing volumes flood unlit trading venues, the New York Stock Exchange is taking a page from the dark pools' playbook.

By By Peter Chapman

Peter Chapman

Call it "NYSE vs. the Internalizers, Round Two." In what amounts to its second stab at competing with broker-dealers that match orders outside of the public markets, the New York Stock Exchange is looking to replicate the functionality of a dark pool under a proposal filed with the Securities and Exchange Commission in November.

The goal of the NYSE's "Institutional Liquidity Program" is to encourage trading in size by offering brokers and exchange market makers two new hidden order types that will allow them to transact in the dark. The proposed one-year pilot program would target a specific segment of the NYSE's customer base much as the exchange's 16-month old Retail Liquidity Program does.

Joe Mecane, NYSE Euronext

Both programs are structured to compete against services offered by brokerages that match up institutional and retail orders with similar orders or the brokers' own positions inside the brokers' automated trading systems.

"When we launched the RLP, we spoke with a lot of institutions, and part of those discussions revolved around the possibility of doing something similar with institutional-type orders," said Joe Mecane, head of U.S. equities at NYSE Euronext, parent of the New York Stock Exchange. "So, as we've gotten some experience with RLP, the question is: Is there a different mechanism that would work better for larger-type orders?"

For the past few years, NYSE Euronext and other exchange executives have repeatedly complained that broker-dealers were syphoning orders away from the public markets, and internalizing them, or matching them up within the brokers' own operations. In other words, wholesalers-such as Citi, KCG Holdings and Citadel-cordon off retail flow, while bulge bracket brokers steer their institutional customers' orders into their own alternative trading systems, or dark pools.

By steering their customers' orders into their own systems, the brokers deprive the public markets of valuable orders and potentially impair the price formation process, NYSE and other exchanges have charged. Brokers trade about 37 percent of all shares away from the exchanges, according to data published by BATS Global Markets.

The exchanges themselves have made their unhappiness with dark pools known. Earlier this spring, NYSE Euronext's Duncan Niederauer, Nasdaq OMX Group's Robert Greifeld and BATS Global Markets' Joseph Ratterman traveled to Washington, D.C., to meet with SEC officials in closed-door meetings. Later, with Nasdaq OMX, the NYSE pressed regulators and legislators to make changes to the market's structure that could drive more flow to the exchanges.

At the same time, the two largest exchange operators have taken steps to compete with the internalizers. In 2011, the NYSE proposed its RLP, which promised price improvement on qualified retail orders. That is a service traditionally offered by wholesalers.

Brokers fought the initiative, but the SEC ultimately approved it. RLP launched in August 2012 and was quickly copied by Nasdaq. The program has not been a huge success, however, accounting for only about 1 percent of NYSE's share volume.