SEC Eyes Dark Pool Crackdown

SEC Eyes Dark Pool Crackdown

The Securities and Exchange Commission (SEC) is planning on curtailing trading on non-transparent “dark pools” by encouraging the use of more regulated and transparent exchanges, according to a report in the Wall Street Journal.  The move aimed at dark pools could “deliver a blow to bank trading operations,” the report noted, as it pointed to another SEC’s goal to boost trading in stocks of smaller companies by increasing the “tick” size under which stocks are bought and sold on the exchange.

Regulatory crackdown on questionable activities considered only a matter of time

Observers in the derivatives industry had been viewing dark pools with relative amazement, waiting for a regulatory crackdown on what is considered blatantly questionable activities.  This includes the generally opaque nature of the “dark pools,” particularly in regards to exchange trading rules, considered a basic regulatory violation of proper market structure. Issues expected to be investigated included allowing dark pools engage in generally opaque payment for order flow and the ability to keep hidden certain order types resting on the exchange as well as conditional orders that enable the seemingly display of stock pricing and liquidity that doesn’t in fact exist.

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The crackdown on dark pools and their ability to skirt common regulatory market rules could lead some to shutter and others to change their business model.  Last week ValueWalk reported that the IEX exchange was considering a move to become a more regulated exchange in light of regulatory pressure that many in the derivatives industry had expected to come.

SEC planning widening of tick pricing

The plan would increase the “spread” by widening the “tick” increments that investors pay on shares of lightly traded stocks from pennies to five-cent and 10-cent increments.  While consumer advocacy groups have initially opposed anything that increases costs to investors, the relative small impact a move from pennies to five cents, for instance, would have relative to overall investor costs isn’t considered as big an issue as is the ability to attract a broad and diverse group of market makers who simply can’t provide two-sided liquidity at spread prices that are pennies or fractions of pennies wide.  It is the increased liquidity from a more diverse group of market makers that is viewed as lending support to market structure relative to the relatively small, almost insignificant price increase.

Larry Tabb, founder and CEO of Tabb Group, who also sits on a CFTC committee on market structure, has previously advocated in favor of increased transactions costs, specifically citing market makers as a potential beneficiary. Tabb reasons that if the goal of a stock market is to retain “sticky” investors a rise in transaction costs would achieve that. Low transaction costs make it easy for investors to get out of the stock market,” he said in an interview two months ago.

Some exchange industry organizations and large exchange players have been previously opposed to the idea, the report noted.  “We have been clear since day one that we’d like to see a tick-size pilot and we think it should… not introduce other variables such as trade-at,” Jim Toes, head of the Security Traders Association, an industry group, was quoted in the report saying.

The broad pilot program proposed by the SEC currently has bipartisan support among two commissioners, while the tick-size program has been a priority for SEC Chairman Mary Jo White for some time, according to the report.

Mark Melin is an alternative investment practitioner whose specialty is recognizing a trading program’s strategy and mapping it to a market environment and performance driver. He provides analysis of managed futures investment performance and commentary regarding related managed futures market environment. A portfolio and industry consultant, he was an adjunct instructor in managed futures at Northwestern University / Chicago and has written or edited three books, including High Performance Managed Futures (Wiley 2010) and The Chicago Board of Trade’s Handbook of Futures and Options (McGraw-Hill 2008). Mark was director of the managed futures division at Alaron Trading until they were acquired by Peregrine Financial Group in 2009, where he was a registered associated person (National Futures Association NFA ID#: 0348336). Mark has also worked as a Commodity Trading Advisor himself, trading a short volatility options portfolio across the yield curve, and was an independent consultant to various broker dealers and futures exchanges, including OneChicago, the single stock futures exchange, and the Chicago Board of Trade. He is also Editor, Opalesque Futures Intelligence and Editor, Opalesque Futures Strategies. - Contact: Mmelin(at)
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