Fishing in dark pools

6 Oct 2015

Dark pools have been hitting the headlines for all the wrong reasons, but navigated correctly can be a valuable tool for large trades. Emma Cusworth reports.

“What is shocking is that people have been shocked by some of the stories that have emerged about infractions at some dark pool providers.”

Jason Lenzo

The post-crisis trading environment is starkly different. Despite the general push towards greater transparency across the financial world, trading is heading in the opposite direction. While average trade sizes on ‘lit’ exchanges have plummeted, finding ways to minimise market impact but still trade efficiently has pushed more and more trading into the dark.


‘Dark pools’ of liquidity – private trading venues so called because of their lack of transparency – have become an important part of the trading ecosystem and are now reported to account for around a third of trading in US securities and around 12% of FTSE 100 trading.

According to Craig Campestre, managing director of SunGard’s Fox River Execution Solutions: “Today there are well over 40 dark pools, which are necessary in the market, especially on the institutional side, where large orders need to be executed. They are the best way to get price discovery without giving away how you’re trading.”

Data from Blackrock shows the average US trade size has dropped 75% since 2004 making it harder for institutions with considerable assets under management to alter allocations without being spotted by opportunistic traders. Interestingly, the Blackrock figures also show little real change in average daily stock turnover in the S&P 500. Despite peaking in 2008 above 1.5%, the average daily stock turnover of the S&P 500 is only slightly above its 2004 levels, clocking 0.7% in 2014.

Block trades of 10,000 shares have become a rarity rather than the norm, however, falling to around 8% of total volume of trading in NYSE-listed companies from over 50% in the mid-90s.

In order to carry out a large trade on a lit exchange, it would need to be broken down into ever smaller parts, meaning traders must continuously post bids or offers on those stocks over whatever period of time it takes to complete the trade.

“Doing so would result in a bad price as the stock would move against you and you could also cause some instability in the market,” says Michael Horan, head of trading at Pershing BNY Mellon.

The change in market dynamics makes it increasingly difficult for investors to conduct large trades on transparent lit exchanges without giving their strategy away and exposing themselves to a significant market impact. For many institutional investors that could, for example, add materially to the costs of transitioning a portfolio.

The need for darkness was the main reason why these private exchanges came into being – so institutions could trade big blocks of securities away from lit exchanges so they didn’t impact the ‘lit’ price.

Consider, for example, an institutional investor with a large portfolio of large-cap equities that need to be transitioned.

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