June 4, 2009 / 2:15 AM / 11 years ago

Bank-run dark pools swelling in U.S. stock markets

TORONTO (Reuters) - Big banks are executing an increasing percentage of U.S. stock trades within their own walls, capitalizing on the credit crisis and enticing the most active traders away from the traditional exchanges.

“Dark pools,” where orders are anonymously matched so that traders do not alert the wider market to their intentions, have triggered concerns that stock pricing may not be transparent.

But the growth of those run by broker-dealers such as Goldman Sachs and Credit Suisse are squeezing other “dark” electronic trading venues, as well as exchanges, resulting in lower fees.

The bank-run dark pools have only recently gained some traction in Europe, while other countries, such as Canada, are watching closely for signs of success or failure as U.S. equity markets fragment into some 40 venues.

Although executives and market watchers expect to see new U.S. rules to ensure public and accurate pricing of stocks, they also expect the private pools to grow beyond the relatively small niche they now occupy.

“The dark pools are definitely going to grow; the wild card is any new regulation,” said Dmitri Galinov, director and head of liquidity strategy at Credit Suisse’s advanced execution services, running the bank’s CrossFinder dark pool.

Banks’ internal dark pools have benefited from Regulation NMS, rules enacted in the last few years to help investors get the best price, and from the pricing of stocks in smaller increments, known as decimalization.

Dark pools owned by brokers and large market makers accounted for 70 percent of all dark U.S. equity volume in April, up from 64 percent in December and from 58 percent a year earlier, according to Rosenblatt Securities, a widely referenced agency broker that tracks 18 dark pools.

Overall, dark market share rose last year, but in the last eight months hit a ceiling near 9 percent of the U.S. market.

Dark pools, which usually publish trades to the consolidated tape with little detail well after they are executed, have been around for decades, but their brands have gained more exposure in the last few years.

Goldman’s Sigma X was the largest in April, followed by market maker GETCO’s Execution Services, and Credit Suisse’s CrossFinder — the winners benefiting from the collapse of other investment banks such as Lehman Brothers.

Justin Schack, vice president of market structure analysis at Rosenblatt, said broker-run dark pools had grown because they’re faster, cheaper and open to algorithms — the computerized trading programs that dominate the market, especially during volatile periods such as last year’s crash.

“Market structure has changed over the last five or six years in ways that favor small size, rapid-fire trading,” Schack said.

The most successful bank-run dark pools have steady participation from individuals, or retailers, whose standing trade orders are gobbled up by high-frequency players who use algorithms and account for about 65 percent of the market.


The U.S. market share of larger exchange operators NYSE Euronext and Nasdaq OMX, which run the New York Stock Exchange and Nasdaq Stock Market, respectively, has dropped in the last year as BATS Exchange, Direct Edge, and the dark pools gained ground.

While the competition has driven down trading fees, an internal pool also reduces the parent bank’s exchange costs by integrating orders from customers and in-house trading desks.

“Brokers are doing a better job of harnessing all our order flow before it goes to the public exchanges,” said Rishi Nangalia, managing director and global head of business development of Goldman’s electronic trading.

But regulators, exchanges and others have raised concerns that dark pools do not publicize their quotes, that there is a general lack of comprehensive data on them, and that some provide early messages, or “looks,” to specific market players about upcoming orders.

“I am concerned that (undisplayed quotes) may not promote public confidence in the equity markets,” James Brigagliano, co-acting director of the U.S. Securities and Exchange Commission’s trading and markets division, told a major market structure conference in New York last month.

Most executives at bank-run dark pools told Reuters they would welcome new U.S. oversight, but noted that competing trading venues help lower trading costs. Others see the growth in these dark pools as an experiment in progress.

“There would be instant vilification from the rest of the public” if a Canadian bank launched an internal dark pool, Doug Clark, managing director of quantitative execution services at Bank of Montreal’s capital markets division, told Reuters on the sidelines of a trading conference here. “So I don’t think they’re going to do it.”

Last week, NYSE Euronext urged the SEC to examine the impact of the early looks at some U.S. venues. But without new regulation, bank-sponsored dark pools will continue to swell, said Rosenblatt’s Schack.

“Most brokers want to execute trades as quickly and cheaply as possible,” he said. “I don’t know that we’ve reached the limit because there are some firms with big equity businesses out there that still haven’t maximized the potential to internalize orders in their dark pools.”

Reporting by Jonathan Spicer; Editing by Lisa Von Ahn

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