Dark Pools going strong

Despite regulatory concerns and consolidation worries, the Dark Pool business is still showing enormous strength. New dark pools venues are implemented regularly and the profits are looking solid.

Reflecting this strength, LiquidNet has now filed for a $500 million IPO. Goldman Sachs and Credit Suisse Securities are overseeing the transaction. Despite the generally weak IPO markets, there is the expectation that this will be one of the strongest public offerings of the year.

Dark Pools: A Regulatory Tangle

An increasing vocal chorus is asking when regulators are going to step into Dark Pools. The Dark Pool market represents the wild frontier in equity trading. Dark pools now represent over 10% of stock market volume and over 20% of all trades in NYSE stocks.

In years past, ECNs represented the upstarts that were edging in on the business of the exchanges. The proliferation of electronic exchange networks fractured the market and siphoned trades off the major markets. ECNs were seen as a threat to the orderly operation of the market according to many older-schoolers. Over the past years the ruckus died down as many ECNs were merged out of existence; many being acquired by the very exchanges that squealed about the menace they posed. One glaring example is the Archipelago ECN, famous for making fun of Wall Street exchange floor market makers, being acquired by the NYSE.

In comparison the major exchanges seem to be awfully quiet today about all the trading volume appearing on Dark Pool networks. These exchange mechanisms were created by major brokerage firms to move large blocks of stock.

One primary concern is the lack of transparency in the market. Exchanges and ECNs provide details of every trade. These venues allow all the participants in the market to discover pricing and be fully included in the overall market. The hidden fractioning of price information with Dark Pools has led to gaming of the market within Dark Pool networks, as traders utilize the mechanism as a profit driving instrument rather than simply as a tool to execute large orders without moving price.

Regulators appear to be absolutely confused in regards to the proper way to address the Dark Pool phenomenon. At most they mention the subject in speeches without outlining any policy or actions. The lack of action is disturbing considering the requirement for proper transparency in the markets in order to maintain the confidence of the investing public.

With the increasing number of Dark Pools, there is the expectation that consolidation is coming. The proliferation of dark pool networks has led brokerages to offer interfaces that link dark pool and “light pool” networks, or offer access to multiple dark pools. These offerings have simply increased the gaming of the system and the utilization of algorithmic trading over the networks.

At some point the news media will start focusing on the abuse of Dark Networks causing regulators angst, and leading Congress to demand more transparency for the investing public. This day may not be far off --- as the Dark Networks continue to quickly grow in market share and an increasing number of trades are hidden from investors.

Dark Pools - Is Consolidation Coming?

The number of dark pools have doubled to over 40 since the start of last year. The success of these alternative trading venues shows excellent prospects for this industry; but the sheer number of firms is a sign that some consolidation will occur. Obviously all 40 firms will not be successful as independent entities in the long term.

The most likely survivors are those backed by large brokerage consortiums. LeveL and Bids have reached an average combined daily trading volume of 50 million shares. LeveL was created by Citi, Credit Suisse, Fidelity Brokerage, Lehman Brothers and Merrill Lynch late last year. Bids was launched in spring and backed by twelve brokerage firms, including Citi, Credit Suisse, Lehman and Merrill Lynch. Notice that some firms have backed more then one single Dark Pool electronic trading venue.

There is an expectation of increased regulatory scrutiny of Dark Pools because they operate outside the scope of the public market, and may undermine individual investors causing them not get the best prices for their trades. This may add increased oversight and costs that will help drive consolidation in the Dark Pool industry.

Similar to how the multitude of ECNs consolidated over time, the expectation is that a similar set of mergers will occur with the Dark Pool firms.

Trading volumes rise in dark pools
http://www.financialnews-us.com/index.cfm?page=ushome&contentid=2448328357

More Dark Pools: The Secret Stock Market

Story from MarketWatch...

The secret stock market
'Dark pools' and other new-age exchanges rewrite the rules, under the radar

NEW YORK (MarketWatch) -- Fourteen floors above Seventh Avenue, in an office more than a mile from the trading floor of the New York Stock Exchange, a trumpet sounds reveille over a loudspeaker.

Liquidnet Holdings Inc., an alternative trading system used by institutions, has just executed a block trade of a million shares or more.

Unlike the bulk of trading in stocks, this trade was made anonymously and was executed outside of the market where retail investors and institutions meet. And unlike a trade on the floor of the New York Stock Exchange, no one will ever know who put a million shares up for sale and who just bought them.

Liquidnet is one of dozens of new private trading networks that -- in just two years' time -- have ushered in a sea change that challenges Wall Street's top institutions while posing vexing questions for regulators and investors alike. [more at below url]

http://www.marketwatch.com/news/story/secret-stock-market-upstart-systems/story.aspx?guid=%7B11EB6EC9%2D6D71%2D43C9%2DADD2%2D59C6B9E3C5D1%7D

Everyone is jumping into Dark Pools

Just a quick update on dark pools...

"The number of dark liquidity pools has doubled to more than 40 since the start of last year. The big names are jumping in. Goldman Sachs, Merrill Lynch and Credit Suisse are among those who have started more dark pool services. Goldman's Sigma X is a good example. The proliferation of dark venues has come as institutions have found it particularly vexing to execute small- to mid-cap stock trades." - from FierceFinance

Dark liquidity pools make a splash with US traders
http://www.financialnews-us.com/?page=ushome&contentid=2347636817

"Dark Pools"

First, let me thank many people for the feedback I have received about this blog. I have been urged to post some of the “non-internal” summaries that I discuss on investlist in this blog so that external folks can benefit from the information. I am still working on two larger articles; one is a look at Housing moving forward into 2007, and the other discusses the mechanics of 401K portfolio creation.

Many people have asked in the past, “How are brokerage firms able to trade stocks outside the market?” The answer is “Dark Pools”.

Basically big institutions have long sought the ability to anonymously trade large blocks of stock with minimal market reaction. This has made so-called “dark pools”, essentially a secretive matching system for large orders, a growth market. LiquidNet, Nyfix Millenium and other firms have started-up over the past couple years that provide this capability, more are announced every month.

The daily volume of these firms that provide "dark pool" capability has risen rapidly. Many brokerages and exchanges want to get in on this trend. NYSE, Nasdaq and the International Securities Exchange have all said they would pursue the niche. Nasdaq is offering its Intraday Cross for free for a limited time.

The key issue to the investor regarding these “dark pools” is the lack of transparency. Your order may be implemented as part of a block outside the public market, and the information from “dark pools” are not displayed as public pricing information. This will likely lead to you not getting the best price for your shares.

It is easy understand why the exchanges would want in on these crossing networks; utilization of “dark pools” for crossing large blocks are causing their public volume to drop. The lack of transparency for these types of block trades when implemented by an exchange still must be troubling to regulators however; the entire purpose of an exchange is to promote an open market. Broker-dealers would even have a tougher time getting regulatory approval to act as a principal in this market, as well as competitive concerns about information advantage.

Some Articles
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Diving Into Dark Pools
http://www.iddmagazine.com/idd/fierce_finance.cfm?id=13548&issueDate=current

Dark Pool and Crossing Network Volumes to Triple to 1.5 Billion Shares a Day in 2010, Says TABB Group
http://www.tmcnet.com/usubmit/2007/01/30/2291030.htm

The Evolving Block Trade
http://www.tradersmagazine.com/regulatorydetail.cfm?id=121&src=home

Hidden Orders and Dark pools Are Taking Order Secrecy on Wall Street to a New Level
http://www.advancedtrading.com/showArticle.jhtml?articleID=197001373

Dark Pools and the Tactical Side of Trading
http://www.minyanville.com/articles/index.php?a=12076