The Sydney-based Capital Markets Cooperative Research Centre (CMCRC) has looked into North American dark pools. It doesn’t like what it sees. Its findings are likely to generate some controversy.
CMCRC is an Australian independent academic centre for capital markets research. It believes that segmentation is costing US investors billions of dollars because it has led to a deterioration of market quality. They are confident that dark trading is the direct cause of this deterioration.
Authors Dr. Frank Hatheway, Dr. Hui Zheng and Dr. Amy Kwan say that the effects of order segmentation by dark venues are damaging overall price discovery.
They have compiled a study which looks at the US market and examines the effects of approximately three hundred venues, including thirteen registered exchanges, approximately 40 alternative trading systems (ATSs) and a number of broker-dealers’ platforms.
Their study concludes that these venues are actively wooing orders “unrelated to the short-term directions of future price movements away from primary markets and that this activity results in higher transaction costs across all venues, and lower price efficiency overall.”
The study says that with the exception of block trading, not only do dark pools fail to bring positive benefits, nor even have a neutral impact, they have a negative effect through higher transaction costs and lower price discovery.
The group has made three policy recommendations. Fair access requirements should be modified and the 5% threshold of exemption from lit market regulations be reduced. There should be harmonization of tick sizing. Lastly, regulators should demand that participants demonstrate meaningful price improvement as a result of dark executions, and look at ways to effectively prioritize lit orders.