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Dark Pools of Liquidity
Corporate Finance
A Presentation by:
How Dark Pools of Liquidity Work and their effect on the U.S. Financial System
John AbbottSamia BagdadyKunal Bavishi
Andre SanchezTodd Vivenzio
Dark Pools of LiquidityBackgroundWhat are Dark Pools? When Did they Arise?
• Dark Pools of Liquidity are ways that investors/financial Institutions can hide their orders
• Has existed for a while, just under different names• “Upstairs Market” at NYSE• Black Pool• Alternative Trading System (ATS)• Crossing Networks
• Became very popular in the 1980’s• Rise in computer use facilitated “Dark Pool” growth
Dark Pools of LiquidityBackgroundWhat are Dark Pools? When Did they Arise?
• Unlike the “Open” NYSE Exchange, “Dark Pools” draw price from market
• “Dark Pools” do not impact the market price
• Details of transactions do not have to be reported to market
• Becoming increasingly popular among Hedge Funds and Brokerage firms
• Sell large positions anonymously• Strategic edge over firms that trade
large volume in open market
Dark Pools of LiquidityBackgroundWhat are Dark Pools? When Did they Arise?
How much are Dark Pools of Liquidity Growing?
Percent of Total Equity Trad-ing Transactions (2007)
ATSOpen Market
10%
90% 2006 2008 2010 2012 20140%
20%
40%
60%
Growth of "Dark Pools" in Equity Markets (Projected)
ATS T
rades
Tota
l M
ark
et
Com
posit
ion
Only Comprise 10 % of Equity Trading……but are growing at an enormous rate (40%!)
Dark Pools of LiquidityBackgroundWhat are Dark Pools? When Did they Arise?
• What are the Main Drivers for “Dark Pool” Growth?• Main role was to provide a “crossing network” to match sellers/buyers• Now biggest drivers are…
• Speed Trading• Algorithms• “Sharing of Dark Pools”• Locking out other firms and individual traders…ethical?
Dark Pools of LiquidityUses of Dark Pools of LiquidityHow are they used? What are their advantages? What are ATSs?
• Normally, equities are exchanged on open markets • NYSE• NASDAQ
• This presents several disadvantages to sellers• “Open Market” = Lack of privacy• Technical Pressure
• Large # Shares Sold• Broken into Blocks• Higher Supply, Lower Price
50,000shares
10,000
shares
10,000
shares
10,000
shares
10,000
shares
10,000
shares
2$/share
Time
1$/share
Dark Pools of LiquidityUses of Dark Pools of LiquidityHow are they used? What are their advantages? What are ATSs?
•Dark Pools are Closed Exchanges•Also called ATS (Alternative Trading System)
• Buyer & Seller = Anonymous• Don’t have to Break up shares
• As a result, faster trading• Cheap for sellers! 0.5 - 2¢/share
50,000shares
10,000
shares
10,000
shares
10,000
shares
10,000
shares
10,000
shares
Dark Pools of LiquidityUses of Dark Pools of LiquidityHow are they used? What are their advantages? What are ATSs?
0%
10%
20%
30%
40%
50%
60%
70%
80%
200775% of Equities
Traded on Open
Markets
201162% of Equity
Traded on Open
Markets
ATS Impact on Open Market Equity Trading1
Perc
ent
of
Equitie
s Tra
ded o
n
Open M
ark
ets
(N
YSE, N
ASD
AQ
)
Figure 1.1 – ATS Impact on Open Market Equity Trading1Source: Aite Group Independent Research, 2007
• Traditional exchanges have grown worried
• “Dark Pools” (ATSs) have funneled away business
• NASDAQ/NYSE have forged partnerships with foreign exchanges
• Also purchased smaller ATS exchanges
Dark Pools of LiquidityUses of Dark Pools of LiquidityHow are they used? What are their advantages? What are ATSs?
No. of Dark Venues
Source: TABB Group Estimate
18 27 32 45 52 533 4 9 21 29 36
1.5%
4%
7%7.
5%
12.5
%
1%2% 2%
3%
5%
10%
11.5
%
2005 2006 2007 2008 2009 2010
US Europe
% Traded Volume(dark)
Dark pools are steadily gaining market share in both the US and Europe
• Although studies don’t agree on the %age, they all agree “dark pools” are growing• Domestically and Globally
Dark Pools of LiquidityPotentials for AbuseDo Dark Pools have potential for Abuse? Have they been abused?
• Lack of Transparency = Lack of Regulation• Lack of Regulation = Abuse?• Open markets work with the SEC
• Cooperation occurs to Investigate potential abuses/fraud
• SEC can fine…heavily• SEC fined NYSE/Nasdaq
$8.25 million…for failure to keep emails
• Gives SEC leverage with regards to regulating/implementing rules in open markets
Dark Pools of LiquidityPotentials for AbuseDo Dark Pools have potential for Abuse? Have they been abused?
• In closed markets (ATS’s), there is little to almost no regulation• Buyers & sellers essentially, regulate themselves
• Can we really trust large fund managers to regulate themselves?
• “Why regulate when were making money?”
Dark Pools of LiquidityPotentials for AbuseDo Dark Pools have potential for Abuse? Have they been abused?
• Recent years financial modeling and computerized high volume fast paced trading have changed the marketplace• In a closed exchange, this could lead to abuse• Primarily, Pricing arbitrage
ar·bi·trage [ahr-bi-trahzh] –noun the simultaneous purchase and sale of the same securities, commodities, or foreign exchange in different markets to profit from unequal prices.
Dark Pools of LiquidityRegulations regarding Dark PoolsAre Dark Pools Regulated?
• Dark Pools lock out the “little guy”!• People who don’t buy in large blocks• Individual Traders• Is that really fair?
• Regulation changes depending on country
• Asia• Dark pools put on
open exchange• Europe
• MTF by UBS• immediate post
trade data available
Dark Pools of LiquidityRegulations regarding Dark PoolsAre Dark Pools Regulated?
• What about the United States?• SEC is enacting new regulations to tackle unfairness which arises due to ATS use in 3 ways…• Amending the definition
of “bid or offer”• Lowering the trading volume threshold that triggers the ATS order display• Changing the existing joint-industry transaction reporting rules to require post-trade disclosure of the identity of the dark pool on which each trade is executed.
Mary Schapir
oSEC Chair
Dark Pools of LiquidityRecommendationsHow Should Dark Pools be regulated? What do we think?
• Ultimately what began as a “support” system for investors trying to unload large numbers of shares, has become something entirely different• Essentially, we know have a two tier marketplace
• A market for low volume trading that is open and regulated
• Another market where large firms can trade huge amounts of shares with little to no regulation or oversight
• Dark pools can potentially be a systematic risk…• Disclosure is essential in a global marketplace