When the Securities and Exchange Commission announced its long-awaited one-year tick size pilot program on June 25, U.S. stock exchange executives and other financial markets experts applauded.
And when they learned the pilot program would contain a trade at provision that would drive more trading to traditional exchanges, likely at the expense of dark pools, they cheered.
The trade at provision will feature one study group of 300 stocks that will test a requirement that dark pools or brokers would have to offer a bid substantially better than that being offered on the lit exchanges. The overall program will test the effect on pricing, liquidity and competition when some smaller stocks are allowed to trade at 5-cent increments.
The trade at provision will provide a bounty of trading data to the SEC, especially concerning the interaction of dark pools, and this could help the agency make future market reforms concerning transparency, pricing and order handling. I think the SEC is directly aiming this feature of the tick program at dark pools in order to gain some understanding and some data of what is happening, said W. Hardy Callcott, a partner at Sidley Austin LLP in San Francisco, and previously an assistant general counsel for Market Regulation in the SECs Office of the General Counsel. Right now, the SEC doesnt have the data to make any decisions on dark pools-Are dark pools beneficial or harmful to customers? The SECs economic data is just not good enough right now to answer that.
Lack of data and cost-benefit analysis has hurt the SEC before, with federal courts overturning SEC rules on proxy access and conflict mineral disclosure because of a perceived lack of study. Now, it appears the SEC wants to cover its bases for any future market reform regulations, especially concerning dark pools.
A year from now, the SEC should have a boatload of data to access for any real market reform attempts, said Adam Sussman, head of market structure and liquidity partnerships at dark pool operator Liquidnet, Inc.
Until then, the SEC is unlikely to do anything substantive with dark pools, although it could try to discourage small retail orders from being filled in dark pools by a tweak in the rules, Callcott suggested. This would move dark pools back toward their initial purpose-to be solely a venue for large blocks of institutional orders, he added.
Callcott cautioned, however, that the traditional lit exchanges shouldnt be too gleeful about what the pilot program data may show-they may be surprised. It isnt clear to me that a trade at rule will result in substantial improvement in execution for small retail trades, said Callcott. I know the exchanges want a trade at rule, but the question is, will retail get better execution with it?
Indeed, after an intense lobbying effort by the traditional exchanges to encourage the SEC to address the problems the exchanges blame on dark pools, it would seem that a lot is riding on what that trading data will show.
Note: This is a sidebar to the August 2014 cover story “The Buyside Rethinks Dark Pools” by Gregg Wirth.
