While block trading will be exempt from new non-displayed trading rules proposed by the US Securities and Exchange Commission last week, some US dark pools are concerned that the exemptions will not apply to small- and mid-cap blocks.
Last Wednesday, the SEC proposed three changes aimed at increasing transparency in US dark pools: requiring ‘actionable’ indications of interest (IOIs) to be published as quotes; lowering the level at which dark pools must make quotes public to 0.25% of a stock’s average daily traded volume from 5%; and forcing dark pools to report trading volumes individually on the consolidated tape. Market participants have 90 days to respond to the proposals.
However, the SEC also proposed an exemption to all three of the requirements for orders of $200,000 or more. While block trading venues have welcomed the proposed exemption, some feel that this definition would be too high to cover blocks of small- and mid-cap shares, which are often executed in dark pools to avoid the higher market impact that results from trading large volumes of less-frequently-traded equities on displayed venues.
“On the positive side, the SEC recognises the importance of protecting block orders. The issue we have is that it is not going to be broad enough,” Howard Meyerson, general counsel and chief compliance officer at buy-side crossing network Liquidnet told theTRADEnews.com. “During the comment period, we are going to be working with our institutional customers to make sure the block order exemption is going to be broad enough to protect the institutional block order. If you don’t protect that block order, you are going to increase trading costs for all the people that own mutual funds.”
According to Investment Company Institute estimates, 52.5 million US households own mutual funds.
“A difficult block trade in a less-liquid security could still fall below the proposed $200,000 threshold,” added Fred Federspiel, CEO of block trading venue operator Pipeline Trading Systems. “Recommending the $200,000 threshold is a great first step at solving the price discovery problem without hurting the block size discovery process, but I think further refinement will improve the rule.”
Meyerson suggested that a block could be defined as 10,000 shares, rather than a dollar value. Under a broad definition, Liquidnet would only have to make “minimal” changes to its operations as a result of the SEC’s rule changes, he added.
The SEC’s proposed dark pool rules may have the biggest impact on brokers’ internal crossing engines, which account for large trading volumes in the US but typically have smaller order sizes than the block trading venues. According to the SEC, dark pools accounted for 7.2% of US trading volume in Q2 2009.
“Some of the brokers will be affected by the threshold requirement because they do such a large amount of volume,” said Cheyenne Morgan, analyst at research and consulting form TABB Group. “They are going to push back against that in the comment period.”
She adds, “I think the SEC will end up revising the threshold up because 0.25% is too low.” Before the SEC’s proposals were announced, market observers had expected the display threshold to be cut to 1-2%.
According to Tim Mahoney, CEO of US block trading venue BIDS, the SEC’s proposals have a specific target. “The SEC’s concern is about the creation of a two-tiered market, which revolves around actionable IOIs and the ability for dark pools to link with others,” he said. “The proposals have made it very difficult for a dark pool to use an actionable IOI.” At the beginning of this year, BIDS launched the New York Block Exchange, a block-trading joint venture with the New York Stock Exchange.
According to comments made by SEC officials at the open meeting where the proposals were unveiled, 11 of the 30 dark venues tracked by the regulator will be affected by the proposals. “It is a very targeted and specific rule to deal with a specific problem,” said Mahoney. “I have yet to find a single dark pool operator who would admit to sending an actionable IOI, although obviously that happens,” said Mahoney.