Dark pools are good for institutional traders and serve a vital function in the market, according to a study released on Wednesday.
Dark pools allow the buyside to trade blocks anonymously, without ‘information leakage’ to other venues, according to Woodbine Associates.
The report, "Dark Pools: Characteristics, Operations and Liquidity," examines four major areas of criticism of the dark trading venues and provides a glimpse inside these opaque order destinations.
Among the criticisms of the dark venues are some admit or allow manipulation by high-frequency traders, off-exchange transactions adversely impact price discovery in the broad market.
This includes information leakage when orders get routed between venues or in the usage of indications of interest. Also covered are the double counting of shares when measuring volume.
"They are not information sieves and are not routing orders all over the place," said Matt Samelson, principal at Woodbine. "There is no secret IOIing going on. With virtually all the operators we spoke with about their order routing processes, all are destinations and do not route orders out."
And for the few venues that do route orders in the form of IOIs, Woodbine found that these operators offer clients the option to opt out at their discretion.
The report said dark pools offer numerous protocols and protections that other venues do not. With knowledge of these factors, traders can choose different venues appropriately to optimize trading execution performance.
Another misconception Samelson said was that high-frequency traders are lurking in the pools, executing small trades and thwarting institutions’ desire to execute blocks at the best price.
"Trading in dark pools carries many of the same concerns as exchange or ECN executions carry, including HFT and market making activity and possible "gaming" by counterparties," the study reported. "Dark pools most often take action to combat and/or alleviate such concerns with analytics, special order requirements or capabilities, and active policing of executions in their pool."
"Dark pools are not evil, as some have portended they are," said Samelson. "They are very beneficial to Wall Street’s institutional traders and Main Street investors."
The study is based on data provided by 19 dark pool operators that transact 95 percent of all dark pool volume.
Woodbine defines dark pools as off-exchange venues that permit institutional and broker/dealer order flow to interact anonymously and often on the basis of volume discovery. The study noted that some 1.5 of every 10 national market security shares that trade use a dark pool.
Woodbine estimates that off-exchange transactions constitute approximately 30 percent of average daily volume.
Agency-broker Rosenblatt Securities, a firm that tracks dark pool volumes, reported aggregate dark pool execution volume as approximately 6.5 percent of consolidated execution volume in 2008. That same figure increased to 13.6 percent by June 2012.
