Disclosing Dark Pool Volumes, Only A Matter of Time

Several Wall Street executives voiced their support for disclosure of dark pool trading volumes, a step that regulators are reportedly considering as U.S. exchanges complain about the loss of volume.

At a Tabb Forum event on Tuesday night, sell side traders debated the pros and cons of U.S. equity market structure and whether there was a better model elsewhere in the world.

The idea of publishing dark liquidity on a monthly or bi-monthly basis in an aggregated format came up several times on the panel, and was favored in contrast to any "brute force" rules.

“We don’t have good data on dark liquidity,” said Dave Weisberger, with Two Sigma Securities, the broker dealer unit of quantitative hedge fund Two Sigma Investments, which acts as a wholesaler for retail order flow. “I haven’t talked to anybody that’s against it,” said Weisberger. “Why doesn’t the market implement a rule that tells us what percentage of their volume is in dark pool vs. exchanges.

“We think that disclosure is the most logical step,” said Vlad Khandros, market structure and liquidity analysis, at UBS Investment Bank, noting that it could be monthly or biweekly. Khandros said that UBS has gone on the record endorsing greater disclose on dark pools.

The over arching theme of the panel, entitled “Continental Divide,” was how to achieve the best market structure for lit and dark markets and what impact that would have on price formation and order competition. Panelists discussed whether or not the U.S. equity market should adopt regulations such as the Trade At rule that was adopted in Canada and Australia.

However, sparks erupted when Sal Arnuk, partner in institutional agency broker Themis Trading, pointed out some of the weaknesses in the current electronic trading market. “Institutions ironically are migrating to dark markets to escape the shenanigans of lit markets, “ said Arnuk, adding that "The lit exchanges are dominated by a game of rebate arbitrage," referring to high frequency trading strategies.

Arnuk said he’d like to see more disclosure on price/time priority. Given the lack of disclosure, Arnuk said buy side firms rely on tags coming back telling participants in dark pools whether the other side is an algo or high frequency trading firm, he said.

Two Sigma’s Weisberger agreed with Arnuk that “ATS rules should be made public, and he also cited the need for good data on dark liquidity. “Why doesn’t the market implement a rule that tells us what percent of their volume is in dark pools vs. exchanges,” suggested Weisberger.

Defending dark pools, Khandros pointed out that dark pools are part of best execution. Tabb Group’s Senior Analyst Sayena Mostowfi cited new rules governing dark pools implemented last October by Canada and Australia in June of 2013. The rules require that dark pools give meaningful price improvement over the displayed market’s quotes, as a way to stem the flow of volume back to exchanges. While Canada and Australia present case studies, the jury is still out. However, Khandros panned the Canadian results, noting that since Canada implemented a rule similar to the U.S. “Trade-At” rule, the firms that are trading more and becoming more profitable are a handful of prop shops. "There is a transfer of volume from retail investors to prop shops and not to exchanges,” said Khandros.

There were some tense moments in the discussion as when Arnuk talked about fragmentation as a problem but Direct Edge's chief of Strategy, Anthony Barchetto, said that fragmentation in any other industry was regarded as a sign of competition. And when Arnuk said that exchanges had experienced a dramatic evolution in terms of less diversity in their order books, Barchetto fired back that his exchange is diverse. "It's a lot more diverse with HFT, arbitrage, bulge bracket, agency brokers. Forty-five percent of the volume everyday is not related to the rebate."