Should Dark Pools Be Prohoibited?
Essay Preview: Should Dark Pools Be Prohoibited?
Report this essay
[pic 1] Department of Accounting and Finance M.Sc International Banking and Finance International Financial Markets and Banking 2017-2018 Task -DShould dark pools be prohibited? Discuss this statement by exclusively presenting arguments that this is not the case.Student Name- Amit Gumasta Reg. No. – 201759331Word count -1236 Juliane Thamm6th November 2017 According to Shorter and Miller (2014) Dark Pools generally refers to electronic stock trading platforms in which pre-trade bids and offers are not published. They further state that Price information about the trade is only made public after the trade has been executed. Orders submitted to Dark Pools are called dark orders and the trades arising because of such orders are known as dark trade or dark transactions. Research by Pan (2017) shows that orders which are executed on Dark Pools are reported to trade reporting facility and recorded to national consolidated tape as over the counter transactions. After an order has been executed, Dark Pools are not required to disseminate as much information about that order as their exchange counterparts. Nimalendran and Ray (2014) Most of the Dark Pools act as representative and fulfil buy and sell market orders at prices which are derived from the National Best Bid and Offer (NBBO). Aquilina et al. (2016) Orders which are generally sent to Dark Pools for execution carry a price limit- the maximum price at which a participant is willing to buy or the minimum price at which participant is willing to sell. In my opinion, Dark Pools have witnessed growth in response to investors demands for protection against information leakage in a constantly changing trading environment. Study by Petrescu and Wedow (2017) suggests that the emergence of Dark Pools mark the first time that exchanges operating fully outside transparency requirements attracted substantial volumes of trading. (Preece, 2013) states that advancement in technology has led to reduction in order and transaction sizes in equity markets followed by significant fragmentation of liquidity across numerous trading venues. He further suggests that under such circumstances, Dark Pools become more feasible for institutional investors as they can place large orders over fewer trades while minimising market impact. Agini (2017) insists that Dark Pools provide investors the opportunity to shield themselves against traders who are highly technological by not disclosing details about their trading activities.(Popper, 2013) asserts that investors are moving significant amount of their trading activities towards Dark Pools as they have rising concerns about big exchanges like the New York Stock Exchange (N.Y.S.E) and National Association of Securities Dealers Automated Quotations (NASDAQ). Such big exchanges are often hit by technological failures and are becoming more dominated by high frequency traders. Under such conditions Petrescu and Wedow (2017) points out that Dark Pools are emerging as new trading venues catering to the demand of investors for opportunities to trade with reduced clarity and less exposure to information leakage. Research by Garvey, Huang and Wu (2016) in order to find out the reasons for why trading takes place in dark markets they came to the conclusion that more sophisticated traders participate in Dark Pool trading when market conditions in lit markets are testing due to higher price volatility and wider spreads.
Dark Pools should not be prohibited because they have got numerous advantage attached to them. According to Pan (2017) Dark Pools claim to have lower transaction cost compared to other exchanges. Davies and Sirri (2017) insists that traders benefit from lower trading cost on Dark Pools. Transaction cost on Dark Pool can be lowered for investors by executing orders within the National Best Bid and Offer (NBBO) or by offering low discount or commission rates for large transactions. According to Brolley (2016) as Dark Pools offer discounted trading opportunity, those investors can also participate who are not able to trade because of the cost of visible orders. Banks (2010) suggests that by trading on Dark Pools investors save on exchange fees which they have to pay while trading on traditional exchanges. Price improvement is another reason for considerable growth of Dark Pools. Traders are most likely to get better price for their trade than that available on the lit market as pointed out by Aquilina et al.(2016). Garvey, Huang and Wu (2016) asserts that Dark Pools helps in price improvement compared to lit venues on more than 80% of dark orders executed hence allowing traders and brokers executing trades to cut down trading cost. According to Brunnermeier, Pedersen (2005) and Carlin et al. (2007) If an order is executed on Dark Pool execution prices remain unaffected by institutions trading interest. In contrast, if an order is submitted to traditional stock exchange then large orders would cause significant price impact and thus increase trading costs as suggested by Ye (2010). While analysing the data for March 2013 Williams (2013) found that Dark Pools venues such as BATS Dark, BlockMatch, Turquoise Dark and UBS MTF witnessed average price improvement of between 3.7 and 5.7 basis points while liquidnet which serves to institutional block trading witnessed price improvement of 106 basis points.Garvey et al. (2016) holds that traders might prefer Dark Pools for trading large orders, which would otherwise have to be placed as limit order on lit order books. They further argue that such orders might be so large that there would not be sufficient liquidity on lit exchange to execute them immediately because they would consume a lot of the available liquidity on a lit order book. Therefore, advantage of trading through Dark Pools as argued by Eng et al. (2013) is the ability to execute large orders without disclosing trading intent and thus avoiding information leakage that could lower down trading profits.