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Dark Pools: In the Eye of the Storm

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19 November 2013
Arin Ray David Easthope

Abstract

Growing trading volumes on dark pools in the US and Europe during the last couple of years have raised a debate on their implications on market structure, market quality, and trading costs. If the trend continues and more trading moves to the dark in the next few years, it would raise great concern over the future of lit markets.

In the report Dark Pools: In the Eye of the Storm, Celent examines the evolution of dark pool trading in the US and Europe and analyzes some of the current issues raised by dark pools such as market abuse, price formation, and equal access, that are important from a regulatory point of view.

The emergence of dark pools is a result of the ongoing evolution of market structure. However, the changes in market structure over the last five years has also resulted in greater complexity, thereby making it difficult to isolate and evaluate the contribution of developments such as increased dark pool trading to the overall stability and efficiency of the capital markets. Nevertheless, incidents of market abuse that have taken place in the recent past have put dark pool trading under greater regulatory scrutiny. In addition, reducing average trade sizes at dark pools is adding greater pressure on regulators to review whether dark pools are carrying out the functions they were intended to carry out. The average execution size at dark pools in the US has fallen from 430 shares in 2009 to around 200 shares in June 2013.

“Dark pools are an important component of market structure,” says Arin Ray, Analyst with Celent’s Securities and Investments Group and author of the report. “It is important to understand that forcing volumes away from dark pools to lit exchanges may not necessarily result in reduced trading costs and improved market quality.”

“All dark pools are not equal,” says David Easthope, Research Director with Celent’s Securities & Investments Group and coauthor of the report. “A bid to control excessive trading at dark pools could adversely impact investors trading large blocks at specialized venues.”

This report begins with an analysis of the key factors that have led to the growth of dark trading in recent years. The report looks at the evolution of dark trading in the US and Europe and focuses on some of the key statistics relating to the debate of lit vs. dark trading. Then, the report presents an analysis about the future of dark pools, especially relating to the ongoing regulatory debate.

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