Not All Dark Pools Are Created Equally
But there are many different types of dark pools, and it's not clear that the buy side values all of them equally. Some of the dark pools run by electronic market makers, for example, cross with significant retail flow and have become very popular, Tabb's Morgan says.
Based on Tabb Group's analysis of dark pool volumes in February, Credit Suisse's CrossFinder and Goldman Sachs' SigmaX are the largest dark pools, respectively, followed closely by Getco's GETMatched, Barclays LX and Knight Link. Morgan points out that the Getco and Knight dark pools do not rely on resting orders -- rather, they use "ping" technology to match institutional and retail flow. "You don't put orders in and wait while they rest," she explains. "You ping them and receive a match." Both venues had an increase in volume in February, which correlates to high retail broker activity for the month, the analyst notes.
Meanwhile, some market participants suggest the lines between dark pools, internalizers and exchanges are blurring. "The term 'dark pool' that has been adopted by others has been diluted a little bit," says Jaime Selway, managing director at ITG. "What's left in terms of uniqueness is the agency block crossing vehicles. When the buy side is just trying to solve a liquidity problem, that is arguably the most valuable tool they have -- that anonymous serendipity that we try to achieve."
When an institution goes to a block-oriented dark pool, according to Selway, "They care about moving a large piece of merchandise at low cost. When they think about dark pools, they're looking for access to liquidity at the midpoint [of the bid-offer spread] in an anonymous way."
But buy-side firms may have qualms about trading with certain broker-owned dark pools, Selway acknowledges, adding, "They can conceivably be structured in ways that the market makers have certain advantages." For example, they could send indications of interest (IOIs) to other market makers after someone trades in the dark pool. Other dark pools are structured like exchanges, in that they rely on third-party proprietary trading shops or enhanced liquidity providers (ELPs) to make markets, Selway notes.
Light At the End of the Tunnel?
So what does the evolving execution landscape mean for the buy side? "Economics can come into play in terms of routing decisions," says Instinet's Kellner. "You want to make sure those economic decisions are not impacting your execution quality." As a result, he adds, buy-side firms are examining data from FIX tags so they can begin to understand their trades and measure execution quality.
With so many execution venues, however, will there be consolidation or regulatory action? "There's no reason to think there's going to be consolidation in the major broker dark pools," asserts Kellner. But, some market participants have called for consolidation among the independent block pools, such as Liquidnet, BIDS, Posit and Aqua.
Despite the fears about dark pools and off-exchange volumes growing, ITG's Selway maintains that internalization is cyclical and that it will ebb and flow. He expects off-exchange volumes -- from dark pools and internalization — to remain steady, until the Volcker Rule or some new dark pool innovation or exchange event upsets the balance between lit and dark volumes. "The Volcker Rule could step back on internalization, depending on how the market maker rules are defined," he says. "If volatility were to spike like it did in '08, then the lit markets will outperform dark pools."
[In the search for liquidity, the buy side increasingly is turning to dark pools. Or is it?]
Exchange vs. Non-Exchange Share Volume
