VP Market Structure Analysis
Rosenblatt Securities Inc.
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"I’ll be there on time and I’ll pay the cost For wanting things that can only be found In the darkness on the edge of town"
— Bruce Springsteen, 1978.
Even as brokerage commissions and exchange fees continue to decline, many institutions are more than willing to pay the relatively high cost of trading in crossing networks and other so-called dark liquidity pools. Some of these markets charge as much as 2 cents per share, more than five times the typical displayed-market fee for taking liquidity. But also they offer institutions a chance to stealthily access block liquidity, an increasingly elusive quarry on exchanges and other public markets, which are dominated by retail-size orders sent in rapid fashion by computerized algorithms. Trading blocks without displaying price quotes and other sensitive details about their orders often reduces market impact and other implicit transaction costs, making the extra upfront commission well worth paying.
But just how much precious block liquidity can be found in the dark markets beyond the well-lit quotes on the NYSE, Nasdaq and other displayed venues? No one knows exactly, but based on our research the best answer is probably, to borrow a song title from another favorite rock band, “Less Than You Think.” We estimate that so-called dark liquidity pools executed trades involving some 322.5 million shares per day in March, accounting for 3.88% of U.S. consolidated equity volume (see table on page 4). The number of shares executed was up from 285 million in February, but as a percentage of all equity trading volume was down slightly, from 3.94%, as consolidated volume rose in March by 13.6%, to more than 8.3 billion shares per day. Month-to-month fluctuations aside, we find that dark pools account for a much smaller piece of the trading pie than the 15 percent or more often cited by other analysts, pundits and industry professionals. The actual total is probably between five and seven percent, once the pools that are not willing to reveal volumes (most of which are small at this stage) are factored in. It's also important to note that trades executed in public markets using dark or partially dark order types, such as reserve size and hidden orders, are not included in our figures.
In this month's Let There Be Light we're pleased to provide data on a broader range of venues, adding BNY ConvergEx's Vortex and UBS' PIN Cross. We also have included, separate from the main volume table, a listing of dark markets classified by type (see page 8), as we believe there is still a fair amount of uncertainty on the buy side regarding which pools are independent and which are owned by exchanges, brokers or consortia — as well as about which models, broadly speaking, are succeeding so far. And in the volume figures, there are several trends and issues worth exploring. But first, a few words about methodology.
Joe and I spend a good bit of time teaching our toddlers to count. Lucky for them, we don't run a dark pool; otherwise they'd be headed straight for remedial math classes. The truth is, the reported volumes for most non-displayed markets count each share traded twice. To be sure, these markets typically are paid per-share commissions by both the buyer and the seller who meet in their systems. But in some cases a single share traded can be counted three or even four times.
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