SEC Proposes Leveling Playing Field Between Dark and Lit Markets
Traders Magazine Online News, November 17, 2009
The Securities and Exchange Commission's proposed rules for dark pools, published last Friday, attempt to level the playing field between dark pools and displayed markets. The SEC is doing this to ensure that relevant information about quotes and trades that investors need to make trading decisions is publicly available.
"The Commission believes that broker-dealers operating [alternative trading systems] should be subject to quoting requirements that broadly parallel those applicable to other market participants," the regulator said in its proposal, referring to exchanges and electronic communications networks. The SEC said this change could also roll back some of the fragmentation that has taken place in the equities marketplace. This could happen if more order flow winds up in the displayed markets and quotes disseminated by dark pools join the public quote stream, ensuring easier access to more price information.
The rule proposal imposes new, tighter quoting requirements on dark pools that disseminate "actionable indications of interest," which the SEC says are functionally equivalent to quotes. Those pools must either stay completely dark or incorporate the quotes they disseminate (beyond a small amount) into the public quotation data. The proposal also requires dark pools to identify their venues when they print trades. Two of the three changes in the proposal address quoting issues, while the third tackles post-trade reporting of dark pool executions.
For some in the industry, this proposal doesn't go far enough in trying to ensure that dark pools stay dark and do not disseminate actionable IOIs. Andrew Silverman, head of electronic trading distribution at Morgan Stanley, has argued for more than a year that actionable IOIs result in information leakage on large orders. He welcomed the proposal but wants stiffer rules.
"The proposal spoke about pools that send out IOIs," Silverman said. "But a broker can send an IOI from a dark pool, from a smart order router, or from an algorithm. If the SEC just focuses on sending out IOIs from dark pools, brokers can shift [what they do] and send them from their smart routers. That's a hole that will have to be addressed."
Silverman said Morgan Stanley's dark pools won't be affected by the new proposed display requirements. "Our dark pools will largely be unaffected because our dark pools, as well as our order handling infrastructure more generally, are truly dark," he said.
The public can comment on the SEC's 116-page rule proposal on "non-public trading interest" for 90 days after its publication in the Federal Register. The SEC must make a final decision about these rules before they go into effect.
The rule proposal largely conforms to industry expectations about what would be included. SEC executives had publicly discussed some of their plans for dark pools over the last half-year, and provided more information in a public meeting last month. At that meeting, the SEC commissioners unanimously approved the issuance of the proposed rules. The rules were published on the SEC's web site on Friday.
These proposed rules are far from the end of the SEC's focus on dark pools. The SEC said it plans to broaden its query of dark pools in a concept release due out early next year. That document will probe "the benefits and drawbacks of dark liquidity in all its forms, including dark pools, the order flow arrangements of OTC market makers, and undisplayed orders on exchanges," according to the SEC.
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