Exchanges Go on Offense Versus Dark

Terry Flanagan

Non-exchange trading venues are handling as much as 40% of U.S. equity volume, record levels that are prompting exchange operators to step up their dialogues with regulators.

Many market participants say that dark pools and other alternative trading systems play an important role in enabling institutional investors to efficiently trade large blocks. But the concern is that too much dark liquidity, including broker internalization, obscures prices and impairs liquidity by further fragmenting an already-fragmented landscape.

“We’re particularly concerned about the impact on market quality and the deterioration in  displayed liquidity, which we see in the form of wider spreads and more volatility in securities with higher relative off-exchange share,” said Colin Clark, NYSE Euronext senior vice president of strategic analysis.

Earlier this week, Nasdaq OMX Chief Executive Robert Greifeld told regulators that newly listed companies should have the option to restrict the trading of their shares to one or more specified exchanges, so as to avoid dark trading. That followed a meeting earlier this week in which exchange executives met with regulators to air concerns over the increasing prevalence of off-exchange activity.

The rise of dark “is driven by the economics of brokers and their interests in trying to minimize transaction costs,” Clark told Markets Media. “Secondarily there is a lack of consistent trading practices and rules for all venues —  in particular there are things that ATSs and off-exchange venues can do that exchanges can’t, such as segment client flows, trade in sub-pennies, and operate with less regulatory oversight, less transparency, and less disclosure of trading practices, methodologies and fees. There is an unlevel playing field.”

“We’re calling for consistency in trading practices and rules across all venues,” Clark continued. “We would encourage the (U.S. Securities and Exchange Commission) to do own their own analysis as academics have, and as we have — the data is there. By looking at consolidated tape information you can see the market-quality erosion.”

Clark noted recent regulatory action in Australia and especially Canada, where off-exchange trading volume dropped from 5% to 2% after new rules were implemented. “They’re trying to be more preventative in terms of the impact on future market-quality erosion.”

NYSE Euronext is “focused on creating incentives to display liquidity in the market  and limiting the ability to trade in front of public markets — incenting liquidity and quote competition through meaningful price improvement requirements,” Clark said.

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