A street sign for Wall Street is seen outside the New York Stock Exchange in Manhattan, New York City
NEW YORK: Wall Street’s infamous dark pools are getting even darker.
A decade after being engulfed by a controversy that culminated in multiple enforcement actions and a regulator clampdown, these off-exchange trading platforms are touting a way to buy and sell stocks that’s even more opaque.
They’re offering what are dubbed private rooms, gated venues that take the core benefit of a dark pool – the ability to hide big equity deals so they won’t impact prices – and add exclusivity, specifying exactly who can partake in any trade.
Created within the dark pools themselves, the rooms are independent from one another and each is invisible to anyone not invited, raising questions about both market transparency and fragmentation.
But with more than half of all US stock trading now happening away from public exchanges, they’re in high demand from firms eager to choose whom they do business with, often to help them carry out individual orders more efficiently.
“It’s like shopping when you know exactly the item you want, and who and where you are buying or selling it from, instead of going to Walmart on Black Friday,” said David Cannizzo, the head of electronic trading at Raymond James and Associates.
“You’re controlling the terms of engagement.”
Right now, it’s impossible to say how many private rooms exist, or how much activity is moving through them.
Companies operating alternative trading systems (ATS) – the formal term for dark pools – said it’s a minority of their volumes at present, since the growth in demand is a relatively new phenomenon.
But they’re seeing rapid adoption by everyone from broker-dealers and market makers to hedge funds and asset managers, so much so that private room volumes at one major ATS – Stamford, Connecticut-based IntelligentCross – now eclipse the total trading activity at nine rival dark pool operators.
Dark pools are so-called because the trades they handle happen away from the “lit” public exchange.
That helps prevent order details leaking to the broader market and triggering adverse price moves before they can be executed.
But there’s still a downside: a pool is open to anyone, and firms inside never know who their counter-party is in any trade. Private rooms can be even more discreet.
“It’s about exercising control, what liquidity a broker wants to interact with to achieve better execution quality,” said Roman Ginis, chief executive officer (CEO) of Imperative Execution, the parent company of IntelligentCross.
Carlos Cabana, head of equity sales and trading at CastleOak, dubbed the room a “diversity pool”, because the participants are all minority-operated brokerage firms.
While in this instance CastleOak doesn’t know specifically who is on the other side of every trade, it knows it will be one of about 10 counter-parties who meet certain eligibility criteria related to ownership and investment goals.
“Think of it as an apartment that’s hosting a party, and there’s one purpose for the party with only invited guests,” said Cabana.
Thanks to CastleOak’s increasing use of the diversity pool, OneChronos is now its third most-used trading venue, behind only the New York Stock Exchange and Nasdaq, Cabana said.
Private rooms are known by a slew of other names, including hosted pools, restricted access rooms, ATS pools and custom counter-party groups.
They’re gaining popularity in the huge, ultra-fast modern market as a way to help firms avoid losing out against players who may be able to move quicker or who have access to superior information.
For instance, many brokers and market makers are keen to take the other side of retail investor orders.
Those small, less volatile trades are generally unlikely to impact prices – so a market maker won’t see an adverse move occur the instant it agrees to fill an order, as might happen with another type of counter-party.
Brokers who take orders to private rooms typically expect to fill the order at the midpoint of the national-best-bid and offer, assuming the rule of the room is set up that way, which is usually the case.
If for some reason the order is not filled in the room at the midpoint, it can move to the broader ATS where multiple other parties can compete to fill it.
f a broker has bad experiences with a private room, they can change to another, avoiding those counter-parties.
“The problem we have is, how do we identify good versus bad liquidity?” asked Jatin Suryawanshi, global head of quant strategy at Jefferies, who estimated that 15 in every 100 shares executed by the firm’s algorithms currently move via a room.
“In using private rooms, you can prioritise who you want to interact with.” — Bloomberg
