These requirements would involve that information about investor interest in buying or selling stock be made available to the public, instead of to only the members of a dark
One of the main advantages for institutional investors in using dark pools is for buying or selling large blocks of securities without showing their hand to others and thus
avoiding market impact, as neither the size of the trade nor the identity are revealed until some time after the trade is filled.
 Impact to outside investors Hypothetically, a retail “everyday” shareholder in any company could be disadvantaged if a dark pool trade is executed by a seller within
the dark pool getting rid of a large number of that company’s shares, which would thereby cause the price to drop.
 Dark liquidity pools offer institutional investors many of the efficiencies associated with trading on the exchanges’ public limit order books but without
showing their actions to others.
 Dark pools are heavily used in high-frequency trading, which has also led to a conflict of interest for those operating dark pools due to payment for order flow and priority
As long as non-public trades are only a small fraction of trading volumes, the public price might still be considered fair.
 The new regulation allowed the emergence of dark pools through the 1980s that allowed investors to trade large block orders while avoiding market impact and giving
 The next big development in dark pools came in 2007 when the SEC passed Regulation NMS (National Market System), which allowed investors to bypass public exchanges to
gain price improvements.
 Controversy The use of dark pools for trading has also attracted controversy and regulatory action in part due to their opaque nature and conflicts of interest
by the operator of the dark pool and the participants, a subject that was the focus of Flash Boys, a non-fiction book published in 2014 by Michael Lewis about high-frequency trading (HFT) in financial markets.
In turn, if dark pool trades were publicly viewable in the same way, a retail shareholder could prevent loss by selling at the same time, before the price went any lower (assuming
that shareholder is confident the price won’t go back up).
 The bulk of dark pool trades represent large trades by financial institutions that are offered away from public exchanges like the New York Stock Exchange and the NASDAQ,
so that such trades remain confidential and outside the purview of the general investing public.
The ability to trade in sub-penny increments also wasn’t widely disclosed to UBS customers, and was instead pitched secretly to market makers including high-frequency traders,
according to the SEC.
In particular the liquidity that crosses when there is a transaction has to come from somewhere—and at least some of it is likely to come from the public market, as automated
broker systems intercept market-bound orders and instead cross them with the buyer/seller.
 Iceberg orders Some markets allow dark liquidity to be posted inside the existing limit order book alongside public liquidity, usually through the use of iceberg
Share trading performed on platforms available to the public usually come with functionality allowing any user to see how many “now” and “sell” orders are in the pipeline
that day for any individual security on the platform (i.e.
High frequency traders may obtain information from placing orders in one dark pool that can be used on other exchanges or dark pools.
However it was not until the next year that ITG created the first intraday dark pool “POSIT”, both allowed large trades to be executed anonymously which was attractive to
sellers of large blocks of shares.
 In the Pipeline case, the firm attempted to provide a trading system that would protect investors from the open, public electronic marketplace.
However, when large volumes are being traded, it can be assumed that the other side—being even larger—has the power to cause market impact and thus push the price against
For this reason, it is recommended that when entities transact in smaller sizes and do not have short-term alpha, do not add liquidity to dark pools; rather, go to the open
market where the short-term adverse selection is likely to be less severe.
In addition, they prefer not to print the trades to any public data feed, or if legally required to do so, will do so with as large a delay as legally possible—all to reduce
the market impact of any trade.
Dark liquidity pools avoid this risk because neither the price nor the identity of the trading company is displayed.
 History The origin of dark pools date back to 1979 when financial regulation changed in the United States that allowed securities listed on a given exchange to be actively
traded off the exchange in which it was listed.
In that system, investors’ orders would be made public on the consolidated tape as soon as they were announced, which traders characterized as “playing poker with your cards
However, it also means that some market participants—retail investors—are disadvantaged, since they cannot see the orders before they are executed.
This increased responsiveness of the price of an equity to market pressures has made it more difficult to move large blocks of stock without affecting the price.
Paradoxically, the fulfillment of a large order is actually an indicator that the buyer would have benefitted from not placing the order to begin with—he or she would have
been better off waiting for the seller’s market impact, and then purchasing at the new price.
Prices are agreed upon by participants in the dark pools, so the market is no longer transparent.
Such orders will, therefore, get filled less quickly than the fully public equivalent, and they often carry an explicit cost penalty in the form of a larger execution cost
charged by the market.
If the seller was making many small orders across a long period of time, this would not be relevant.
It said UBS let customers submit orders at prices denominated in increments smaller than a penny, something SEC rules prohibit because it can be used to get a better place
in line when buying or selling stock.
The effect of this was to attract a number of new players to the market and a large number of dark pools were created over the next 10 years.
 Price discovery If an asset can be traded only publicly, the standard price discovery process has the best chance of making the public price approximately
“correct” or “fair”.
However, the greater the proportion of trading volume that happens non-publicly, the less confident we can be that the public price is “fair”.
The market impact of the hidden liquidity is greatest when all of the public liquidity has a chance to cross with the user and least when the user is able to cross with ONLY
other hidden liquidity that is also not represented on the market.
However, very few assets are in this category, since most can be traded off market without revealing the trade publicly.
On the other hand, if the buy-side institution were floating their order in the prop desk’s broker dark pool, then the economics make it very favorable to the prop desk—they
pay little or no access fee to access their own dark pool, and the parent broker gets tape revenue for printing the trade on an exchange.
 A review of these forms revealed a number of differences, including “tiering”, “pegging”, and “immediate-or-cancel (IOC)” orders, as well as a special features such as
a speed bump by IEX to prevent high-frequency trading.
 Dark pools allow funds to line up and move large blocks of equities without tipping their hands as to what they are up to.
 UBS fine In January 2015 the U.S. regulators imposed a fine on UBS Group AG’s dark pool for failing to follow rules designed to ensure stock trades are executed
Iceberg orders are not truly dark either, as the trade is usually visible after the fact in the market’s public trade feed.
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Photo credit: https://www.flickr.com/photos/jenny-pics/8708856019/’]