The percentage of shares traded off-board has reached record levels. Is that bad news? Whats behind it? The Securities and Exchange Commission wants to know, but industry officials cant seem to agree on an explanation.
According to data provided by BATS Global Markets, off-exchange trading now exceeds 38 percent of total industry volume. A year ago it was only 33 percent. Most of those shares are either internalized by brokers alternative trading systems-such as dark pools-or their market making systems.
The SEC and exchange officials are concerned that the trend may be leading to a decline in the quality of price discovery in the public markets. At a recent industry conference, SEC Associate Director Gregg Berman asked industry executives for an explanation.
Broker business practices are behind the surge, according to one exchange official. Its easier for a bank to internalize an order and save cost rather than trade it on an exchange, Bryan Harkins, chief operating officer at exchange operator Direct Edge, told Berman at this years market structure conference sponsored by the Securities Industry and Financial Markets Association.
A brokerage executive on the same panel disagreed, arguing that institutional customers prefer executing certain orders in dark pools.
Why are we not displaying orders? Greg Tusar, co-head of global execution services and platforms at KCG Holdings, asked at the SIFMA confab. Because the market has evolved to the point where displaying them actually hurts execution quality. If a client said it wanted to experiment with displaying its child orders, people that run ATSs would be falling over themselves to make that happen.
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Tusar added that even if off-board trading was banned, it would not lead to more orders being posted on exchanges. All that activity would likely move into exchange reserve or hidden order types, he said. That has a lot to do with the optionality you give the market by placing a limit order.
Between 8 percent and 11 percent of all traded orders are done via the exchanges hidden or reserve order books, according to industry estimates. That data is available on the SECs website, but is not broken out by exchange.
For at least one long-time industry observer, the recent growth in off-board trading may have more to do with market conditions.
What we saw with the Flash Crash, when the market was very volatile, is a tendency of the volume to go to the lit markets rather than the unlit markets, Tom Gira, an executive vice president in the Financial Industry Regulatory Authoritys market regulation division, told Berman at the SIFMA conference. But recently weve been in a relatively less volatile period.
