Long-awaited regulatory changes to the dark pool landscape are expected to be announced on Wednesday. The Securities and Exchange Commission, in its upcoming open meeting, is likely to recommend changes to dark pools that could limit the amount of volume executed in these pools.
These changes are expected to occur in the form of a rule proposal that alters elements in Regulations NMS and ATS, according to the SEC. The rule will be proposed by the SEC’s Division of Trading and Markets. A public comment period likely to last 60 to 90 days will follow.
The SEC’s aim is to provide more transparency around dark pool executions and eliminate the possibility that "two-tiered markets" may develop. Two-tiered markets could hurt the ability of customers to get the best executions possible.
In an Oct. 8 speech, SEC Chairman Mary Schapiro outlined several concerns about dark pools. "As dark pools divert an increasing volume of order flow away from the public quoting markets, the potential for market fragmentation is a concern," she said. "Also, where there is less publicly-available information about the trading practices of significant markets, there may be more opportunities for information to be leaked only to favored market participants."
About 22-to-24 percent of the industry’s equities volume takes place away from public markets, including about half of that in dark pools. The off-board volume is several percentage points higher than it’s been in recent decades.
The first recommended proposal to be considered on Wednesday would amend the definition of a bid and an offer in Reg NMS. This alteration, the SEC said, would "address actionable indications of interest." The industry expectation, based on comments by regulators over the last five months, is that actionable IOIs would be considered bids and offers, or quotes, eliminating uncertainty about the status of these messages.
Actionable IOIs include messages routed between dark pools, or between dark pools, exchanges and other firms, designed to seek out liquidity or alert another entity of the presence of orders in a particular security. These messages are by dark pools to source or attract more order flow, thereby increasing the likelihood of executions in those venues.
In her speech two weeks ago, Schapiro observed that not all dark pools are in fact dark. Some, she said, transmit electronic messages to "selected participants that convey valuable information about their available liquidity." That could lead to the presence of "significant private markets to develop that exclude public investors," she added.
The SEC also plans to consider a proposed recommendation to amend the display obligations of alternative trading systems in Reg ATS. The industry expectation is that the SEC will propose lowering the threshold at which ATSs, which include dark pools and ECNs, must display quotes in their books to 1 or 2 percent of a security’s average daily volume, from the current 5 percent. (This will not affect ECNs since they already display their quotes.)
Under these rules, actionable IOIs, which would be deemed quotes, would have to be displayed if a dark pool reaches the lower threshold. This display requirement would, effectively, limit the growth of dark pools since requiring ATSs to publish their quotes runs counter to the rationale for using dark pools in the first place. Dark pools are used mainly to lower market impact costs by not revealing pre-trade trading interest.
The SEC did not indicate that it plans to address the fair access threshold in Reg ATS on Wednesday. Both the display and fair access thresholds are currently 5 percent. If an ATS executes 5 percent of the average daily volume in a security in four of the previous six months, it must display quotes shown to more than one participant at a time and provide broad access to market participants. Industry participants consider it likely that the SEC will ask questions about fair access in any proposed rule that emanates from the SEC’s Wednesday meeting.
The Commission also intends to consider changes to the joint industry plans for disseminating consolidated trade data. According to market participants, this likely refers to new requirements concerning dark pool post-trade reporting. Dark pools must print to the tape within 90 seconds of an execution, although many print immediately. These prints, however, are not identified by dark pool.
The SEC has said many times since last spring that it would like to see more post-trade transparency about dark pool volumes. This could include identifying where trades occur. It could also include specifications requiring dark pools to reveal execution information on a periodic basis. In addition, the SEC may dictate how dark pools should count trades they execute and handle.
Currently, there are no uniform standards, enabling dark pools to count executions in different ways. This has led to uncertainty about how much off-board volume is taking place in individual dark pools. It has also made it impossible for industry participants to know exactly how much volume is occurring in dark pools generally.
TABB Group, a research firm, began tracking dark pool executions in April 2007. Rosenblatt Securities, an agency broker, began tracking executions in dark pools the following year. There is, however, no single place accessible to all market participants that provides dark pool volume figures.
