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FLASHBACK FRIDAY: Coming Out of the Dark

Traders Magazine Online News, October 12, 2018

John D'Antona Jr.

Are dark pools still dark?

If one thinks back to what a dark pool or Alternative Trading System (ATS) was a few years back, they were indeed “dark.” Most traders didn’t know what exactly went on inside them except that when these liquidity centers worked orders got filled. Block orders. Neither who filled a buy or sell order wasn’t known nor how the order was filled. The participants that lurked inside these pools were unobserved and left to their own devices and for the most part, they worked.

But then the public or “lit” exchanges like Nasdaq, Direct Edge and NYSE saw their trading volumes fall (and profits) as institutional order flow switched from their marketplaces to the dark. And they complained. Loudly. Arguing that these pools functioned without regulations that they themselves weren’t subject to and how the retail investor was being hurt by this new undisplayed liquidity, the regulators got involved.

Regulators wanted to know more about these dark pools – who was in them, trade size, timing, etc. Dark pools countered that to give up this information would hurt the buy-sider who traded within it as it would lead to leakage and inferior execution quality. At their first attempt, the regulators failed to get much information or cooperation from the dark pools.

But that all changed on their second attempt. FINRA made dark pools and other ATS report their trading activities in June 2014. This was their statement:

“As part of the Financial Industry Regulatory Authority (FINRA)'s effort to increase market transparency and thereby enhance investor confidence, FINRA today began providing data indicating the activity levels in each alternative trading system (ATS), including all market facilities commonly called "dark pools." This important information will shed light on the securities that are traded in each "dark pool," which occurs away from traditional stock exchanges. While the trades in these facilities are made available on a real-time basis to investors and professionals today through securities information processors (SIPs), these trades are not attributed to a specific ATS or "dark pool.

Under FINRA's new transparency initiative, the public will now be able to see the total shares traded each week by security in each ATS or "dark pool." This data will be provided to the non-professional investing public free of charge and is available through FINRA's website. ATSs account for a significant percentage of total OTC trading in exchange-listed equities in the United States. Currently over 30 percent of the total National Market System volume of shares traded occurs over the counter.

“FINRA hopes that providing a clear view of the level of activity handled by these ATSs or 'dark pools' will increase market transparency and thereby enhance investor confidence. FINRA's commitment to transparency is bringing light to what was previously a dark area of the equity markets. Making this information available to both the investing public and market participants provides an unprecedented view into the activity of these highly significant trading venues," said Steven Joachim, FINRA Executive Vice President, Transparency Services back in June 2014.

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