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CMCRC finds SEC rules favour dark pools
30 July 2014
Findings support the introduction of new SEC rule
SEC trading rules may be providing dark venues with a
regulatory advantage over traditional stock exchanges,
according to a new paper by The Capital Markets Cooperative
Research Centre (CMCRC).
Dark pools, by allowing some traders to circumvent market
order time priority, create a queue-jumping advantage that
has facilitated their rapid growth at the expense
of traditonal lit venues.
"Our study found a sharp rise in dark venue market share when
stock prices are just above the $1 level," Amy Kwan, CMCRC PhD
"The effect isn’t constrained to penny stocks
– high priced stocks exhibit similar behaviours. We
also see that on trading days when stocks are severely
constrained by the minimum pricing increment, dark venues gain
market share as well."
Limit orders submitted to dark venues can execute ahead of
displayed orders on lit exchanges as long as the price is at or
within the National Best Bid and Offer (NBBO). This drags
liquidity away, reducing depth and increasing spreads on lit
The study looked at market depth, particularly around the $1
price level. Regulation National Market System rules mean that
when stock drops below $1, minimum pricing increments fall from
$0.01 to $0.0001.
This means there are strong incentives for traders to migrate
their order flow to dark venues to benefit from queue jumping
when stocks are trading just above $1. This incentive is lost
when the price falls below the $1 threshold.
The study lends support to the introduction of a new rule,
which would requiring dark orders to be routed to lit exchanges
unless dark pools can provide meaningful price improvement
would support depth and tighten spreads on the lit markets
which in turn is positive for price discovery.