Off-exchange Trading, Dark Pools and their Regulatory Dilemmas

Abstract

Exemption from pre-trade transparency on dark platforms enables the prevention of information leakage and a major market impact, thus block traders prefer these platforms to public ones. There are several dark trading facilities: systematic internalisers, crossing networks, etc. In this study, I focus explicitly on dark pools, and analyse why average trade size is decreasing while the number of transactions and the popularity of these venues continue to increase even though dark pools do not necessarily offer meaningful price improvement to investors. While seeking to answer these questions, I highlight that the use of dark pools has increasingly departed from their original purpose. In my paper, I explain in detail that liquidity is shifting dynamically from traditional public exchanges to dark platforms, with possible negative consequences to price discovery on lit venues. Sponsored access to information on dark platforms might harm overall market integrity as well. Although there is no consensus regarding the “useful ratio” of dark trade to lit trade, regulators and decision-makers on both sides of the Atlantic are increasingly concerned about the proliferation of dark liquidity. Both European and US regulators have been making systematic efforts to clamp down on dark ratios and curb the increasing popularity of dark trades. This paper presents current regulatory trends and their possible future changes, as well as their impact on dark liquidity.