When the Financial Industry Regulatory Authority, Inc. (FINRA) in early June released some hard numbers on the trading activity of alternative trading systems (ATS), including roughly 40 dark pools, the financial industry began pouring over the numbers.
For many, it was the first time this data had ever been seen, and some of the numbers were enlightening to say the least. (For example, it showed that bank-owned dark pools controlled much of the market, with those owned by the largest five banks responsible for about half of all dark trading volume.) However, one number stood out as a particularly prickly thorn in the side of many financial market pros.
187.
That number, deciphered through comparing share volume with total trades, represented the average trade size in the top five dark pools – just 187 paltry shares for trading activity for the week of May 12-18. (Worse yet, the average trade size dropped to 166 shares for the latest round of FINRA dark pool data, showing activity for the week of May 19-25, according to the data.) The 187 number stunned some observers because it seemed to undercut what dark pool proponents and operators have been saying for years: That dark pools are primarily used by large institutional traders to move large blocks of stock-trades that would cause havoc on prices in the markets if they were moved over public exchanges.
Indeed, David Downey, chief executive of OneChicago, a registered securities futures exchange, said he remembers when he was a broker on the American Stock Exchange in the 1980s, large institutional orders were often the victim of predatory front-running activity, thus creating a strong need for dark pools. “Now, looking at the average share number-that’s not block trades, that’s not institutional size!” Downey said. “So, if this isn’t [institutional] activity, let’s examine why we allowed this to happen.”
Chris Nagy, Founder & CEO of KOR Group LLC, a market structure-focused lobbying and consulting firm, agreed, adding that the average trade size number is difficult to rectify with the historical reasoning behind the use of dark pools in the first place. “The reasons to go dark, for anonymousness and to keep your large trade from roiling the markets don’t hold water when average trades are so small and dark pool volume is so large,” Nagy said. Total trading volume done away from the public exchanges and instead executed in dark pools and other ATS has reached 40%, almost three-times what it was just six years ago, according to The Tabb Group.
Downey, who admitted he was stunned by the 187 number, said it just demonstrates how dark pools have evolved since they were first created in the mid-1990s. “Dark pools have morphed,” he said. “Now, it’s become a way of keeping market activity from being out in the open,” he noted, adding he’d like to see dark pools return to their initial purpose. “One solution is to push back to what dark pools were originally, what they were created for.”
