A health check for dark pools?

Over the past few years, dark trading has been the subject of considerable attention all around the world and its success in growing market share has everyone talking about this phenomenon.

When they first came into operation dark pools were embraced as an exciting new way to trade large orders with minimum market impact. More recently, however, with the increased levels of HFT and a continuing decline in average trade size, dark pools have become the subject of some concern amongst the regulators. So I couldn’t help but wonder, what is a ‘healthy’ market share for dark liquidity?

On 15th October a new regulation on dark trading was implemented by the Canadian Securities Administrators (CSA) and the Investment Industry Regulatory Organisation of Canada (IIROC) in an attempt to prevent investors from moving away from lit markets. Key elements of the new rule include “visible order priority”, “meaningful price improvement” and “minimum size”. This means all orders will be subject to the “trade-at” rule whereby visible orders will take priority over dark ones when traded on the same marketplace. Worried about pre-trade transparency and price formation, Australian regulators are also considering taking action to limit dark trading, proposing to increase the minimum size threshold for passive dark orders.

So do these measures outline the future of dark pools? While practitioners on both the buy-side and sell-side evidently welcome the services they provide, the regulators seem to have decided on the healthy limit for dark liquidity and prescribed the appropriate medicine to curb any excesses. Just how effective that particular treatment plan proves to be, only time will tell.

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