The Securities and Exchange Commission’s top trading executive laid out a series of broad concerns about dark pools in the U.S. equity markets. His comments signal a potential shift in the SEC’s attitude toward non-displayed liquidity executed in alternative trading systems.
James Brigagliano, co-acting director of the SEC’s Division of Trading and Markets, said dark pools could impair price discovery by drawing valuable order flow away from the public quoting markets. “To the extent that desirable order flow is diverted from the public markets, it potentially could adversely affect the execution quality of those market participants who display their orders in the public markets,” he said. Brigagliano added that anything that “significantly detracts from the incentives to display liquidity in the public markets could decrease that liquidity and, in turn, harm price discovery and worsen short-term volatility.”
Brigagliano spoke in New York this morning at a conference on market structure sponsored by the Securities Industry and Financial Markets Association. He is a 20-year SEC veteran.
Brigagliano also took aim at dark-pool volume-reporting practices. “I’d like to give you specific statistics on the trading volume [of dark pools],” he told the crowd, “but there’s very little reliable public information on dark-pool trading activity.”
The SEC exec noted that some dark pools publish monthly volume figures, but that the lack of uniform reporting standards makes those figures less reliable. Some pools, he said, count both the buy and sell sides of a trade while others single-count their volume. In addition, some pools include “touched” orders in their volume stats rather than just matched trades.
This hodgepodge of reporting practices may not last much longer, based on his comments. It illustrates a “transparency concern that warrants attention,” Brigagliano said. Dark-pool volume is also not identified as such by the consolidated trade dissemination processors. “Their trades are identified merely as non-exchange or over-the-counter trades,” he said.
To remedy this, the SEC, Brigagliano suggested, may impose post-trade reporting requirements on dark pools. “While full pre-trade darkness is an important element of the business models of some dark pools, it does not appear that some form of improved post-trade transparency would be likely to interfere with those business models,” he said. “Indeed, uniform and accurate trade reporting practices could help establish a fairer playing field because those dark pools that report their volumes accurately won’t be disadvantaged in comparison to those that inflate their volume.”
In addition to concerns about price discovery and accurate trade reporting, Brigagliano targeted indications of interest sent between dark pools as another potential concern for regulators. These automated IOI messages, which usually are executable and for small size, are sent to seek liquidity from other dark pools to increase the original pool’s executions. The widespread use of these “actionable order messages could create the potential for significant private markets to develop that exclude public investors,” Brigagliano said. He added that these actionable order messages could affect competition among trading centers and contribute to market fragmentation by making consolidation efforts among dark pools less likely.
In his comments, Brigagliano differentiated between block crossing systems that execute large orders for institutions and dark pools that trade small-size orders. The former may have an average execution size of, for instance, 50,000 shares. The other dark pools, which, he said, execute the majority of dark-pool volume and are “the fastest-growing type of dark pool,” have average trades of several hundred shares, similar to the average size on exchanges and ECNs.
