Greenwich highlights degrees of darkness

A new study from research firm Greenwich Associates has warned institutional investors to be wary of the practices of dark liquidity providers.
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A new study from research firm Greenwich Associates has warned institutional investors to be wary of the practices of dark liquidity providers.

Dark pools have become popular venues for investors looking to reduce market impact and find liquidity for large block trades, through the anonymous or ‘dark’ trading offered on these platforms.

However, the recent survey of 64 institutions – who described themselves as active users of dark pools – found that dark liquidity sources provide contrasting policies on external routing, anonymity and information sharing/leakage.

Forty-five percent of those questioned revealed that dark liquidity sources did not divulge how their proprietary order flow interacts with orders placed by the institution and other agency clients.

Moreover, 35% of respondents said the sell-side firms they use to access dark liquidity do not disclose whether their dark liquidity pools are truly anonymous or whether any information regarding their orders is conveyed to potential liquidity providers.

Results also suggested that determining the level of liquidity in dark pools could be a challenging task. Two-thirds of respondents said broker-dealers and exchanges did not disclose how they calculate volume within the dark pool. The third that did have access to this information believe that matches are double counted with orders routed outside of their dark pools counted as part of the overall volume.

In addition, the survey found there were differing practices in determining what types of orders are accepted and how anti-gaming measures are enforced.

Ninety percent of the survey respondents were from the United States, with the remainder split between Canada and Europe.

In order to get the most out of dark pools, Greenwich suggested that institutional investors ask dark liquidity providers ten questions, which are:

• Are you a true dark pool, (i.e., completely anonymous, without any information leakage) or will information regarding my orders be conveyed to potential liquidity providers?

• Does your platform route orders out of your dark pool or from any other system connected to your dark pool, including your smart order router, to ECNs, ATSs or any other external source?

• If you allow indications of interest (IOIs), is it an opt-in or an opt-out process or will this decision be made for me?

• What information regarding my order will be included in an IOI (i.e. symbol, side, size, and/or price)?

• What type of order flow populates your dark pool (i.e., proprietary orders? retail orders?)?

• How do you count matched volume (single or double count) in your dark pool for purposes of what is reported to the tape and advertised, and are orders that are routed out of your dark pool and executed by another party counted toward your own volume?

• Do you match within the spread or at the spread?

• What anti-gaming controls are in place?

• Do you have a minimum size limit?

• How will my orders interact with your proprietary orders in terms of priority?

Greenwich Associates consultant John Feng, said in a statement, “In nearly all cases, even if the broker/dealer or exchange does not disclose this information up front, they are obligated to provide it upon request.”