Dark pool operators must be more open to clients and regulators if they wish to regain trust following a renewed focus on order handling, according to Jamie Selway, head of liquidity management at agency broker ITG.
Selway's comments come after US block crossing network Pipeline (now known as Aritas) was fined by US regulator the Securities and Exchange Commission (SEC) for improper disclosure on how buy-side orders were executed.
“Pipeline has raised the intensity of the questions being asked at high levels in asset management firms,” said Selway. “People are asking very probing questions. But it’s all to the good if you’ve nothing to hide.”
Pipeline was fined US$1 million last year, after the SEC found that the firm failed to tell clients that the vast majority of orders executed in its dark pool were filled by Milstream Strategy Group, an entity trading entirely owned and funded by Pipeline and managed by former Pipeline CEO Fred Federspiel between 2004 and 2006. Following the investigation, the firm has closed down Milstream Strategy Group, overhauled its senior management team and rebranded.
The investigation has placed dark pools under increased scrutiny from all sides of the industry. Selway argues that requests for information should be coupled with due diligence and visits in person; he also believes it is becoming increasingly common for company CIOs to ask direct questions about dark pools and how they operate.
“There’s a growing recognition of the need to understand how dark pools work, given their increased importance,” he said. “People are wondering, are there more Pipelines out there? The quest for information around the trading process is unlikely to wane anytime soon.”
ITG's US dark pool POSIT reported a 15% annual increase in its average daily volumes in its Q1 2012 results. The platform traded an average of 96.1 million shares per day, an 11% increase on the previous quarter.
According to Selway, POSIT’s advantage is its unambiguous matching system, which offers crossing at the mid-point or the national best bid and offer
The SEC proposed a three-point plan in October 2009 to control the growth of dark pools, which is yet to come into law. The proposals included lowering the threshold at which alternative trading platforms must display bids and offers to 0.25% of a stock’s average daily volume from 5% currently, the introduction of real-time disclosure of executions by all venues and new standards for reporting trades.
There is no filtering or segmentation of clients on POSIT – instead, the mid-point cross is targeted solely at long-term institutional investors. The platform offers no rebates to liquidity providers, nor does it seek to attract high-frequency trading flow, he added.
POSIT is currently focused on investing in its technology to improve throughput rates in line with global increases in trading speed and the quantities of data consumed by financial institutions. But Selway has a parting comment to those who think new regulation is the best means to prevent a repeat of the Pipeline saga.
“We would much rather have rigorous enforcement of the existing rules than policymaking,” he said. “The answer to Pipeline is not a whole host of new constraints on dark pools that add good business and value. Instead, we should ensure we are checking diligently and asking the right questions.”
ITG reported overall revenues of US$136.4 million, compared to US$150.1 million in the first quarter of last year, and US$129.9 million in the fourth quarter 2011. US-based revenues were US$84.6 million in the first quarter of 2012 compared to US$100.5 million a year earlier. Sell-side client volume represented 48% of total US volumes, up from 44% the previous quarter.