Dark Pools: Safe For Swimming?


A proliferation of non-lit trading venues has exacerbated the buy side’s problems with sourcing liquidity in today’s highly fragmented market environment.

In the U.S., the number of dark pools has grown substantially in the years following Regulation ATS, which institutionalized the concept of alternative trading systems, and especially Regulation NMS [National Market System], which prevented ‘trade throughs’, or the execution of trades at prices inferior to protected quotations displayed by other trading centers.

Under Reg NMS, for a quotation to be protected it “must be immediately and automatically accessible”.

Anthony Godonis, senior equity trader, Aberdeen Asset Management

Anthony Godonis, senior equity trader, Aberdeen Asset Management

That lies at the crux of the debate over dark pools, and in particular whether they should be required to provide some sort of price improvements over quotations on the lit markets.

For the buy side, dark pools have come to be identified by their perceived level of toxicity, or interactions with high-speed traders that move in and out of positions in hours, minutes or even milliseconds.

“The issue with toxicity is it’s hard to detect,” said Anthony Godonis, senior equity trader at Aberdeen Asset Management, which has $2.5 billion in assets under management. “Some broker-sponsored crossing networks that are labeled as dark pools still have a lot of high-frequency trading and signaling. We have gone from a few dark pools to more than 40. Some of them are not broker-sponsored, which typically leads to less toxicity.”

Trade-At Rule
At issue is the so-called trade-at rule, which has been proposed by the joint Securities and Exchange Commission and Commodity Futures Trading Commission Advisory Committee on emerging regulatory issues, and which the SEC itself is considering.

A trade-at regime would reinforce the incentive to post displayed limit orders and hence encourage the liquidity and price discovery roles of the market. Such a change in routing would entail substantial costs with respect to technology and implementation.

Under a trade-at rule, a trading center that was not displaying the NBBO [national best did and offer] at the time it received an incoming marketable order would have to either execute the order with significant price improvement or route the order to another venue.

LX, Barclays’ dark liquidity crossing network, aggregates liquidity across the firm, including orders from clients and non-displayed trading partners, to provide users access to a deep and unique pool of liquidity.

LX can be accessed through Barclays Equities algorithmic trading strategies (including Hydra which sources liquidity from multiple dark market venues) and directly from leading OMS and EMS systems including RealTick.

“LX is an integral part of our electronic trading offering, providing clients with enhanced execution quality,” said Bill White, head of equities electronic trading at Barclays. “LX is built on transparency and preventing information leakage. We have built in safeguards to manage toxicity, and to help our institutional clients understand how to manage their interactions with high-frequency traders.”


Anti-gaming technology has been built into LX to protect against information leakage, and execution quality reports enable clients to determine how to best incorporate LX into their trading strategies.

“With fragmentation, average trade size has gone down dramatically,” said Anthony Pallone, head of U.S. equities electronic distribution at Barclays. “As an order gets chopped into smaller pieces, there’s greater chance of it being known in the marketplace. A 50,000 share order might get chopped into 10,000 pieces. Within LX, we are trying to foster block liquidity formation, from both an agency and capital markets perspective, with the end user retaining control over the process.”

Barclays LX is now the second largest dark pool in the U.S., according to Rosenblatt Securities’ Monthly Dark Liquidity Tracker.

LX has seen the strongest growth among competitors, moving up nine places in the dark pool volume rankings over the last four years.

“We laid out a plan two years ago to overhaul our offering end to end, gain market share and provide clients with the best electronic trading tools in the market,” said White. “The dark pool has attracted significant volume over the past year following enhancements to the firm’s technology, algorithmic trading and routing strategies.”

The team has also deepened its relationships with clients and liquidity providers.

“We are consolidating the touchpoints through which a buy side trader interacts with us,” said Pallone. “The idea being that if a single buy side trader has enough sophistication to trade cash products, put on program trades, and trade algorithmically, why can’t they interact with a person on the other end with the same skill set, and who is able to converse with them intelligently.”

Bank of America Merrill Lynch’s Instinct Natural, an enhancement to its alternative trading system Instinct X, is aimed at increasing opportunities to execute block trades while minimizing market impact by providing a central platform where natural flow can interact.

“Buy-side traders have put a greater emphasis on trust and transparency in the market, especially with key relationships for their firms—meaning they realize it’s now imperative to have better connectivity into dealers and trusted relationships to find bigger situations,” said Jason Crosby, global head of portfolio sales and head of Americas institutional execution services sales at BofA Merrill.

Instinct Natural allows the client the opportunity to leverage the liquidity from institutional and private clients trading with BofA Merrill’s high-touch, electronic, ETF and equity derivatives desks.

BofA Merrill believes that as clients become more willing to rest longer in Instinct Natural, they’ll find natural crosses with price and size improvement and minimal market impact.

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