Exchange CEOs meet regulators on dark pools, internalizers

The chief executives of three of the top exchanges met with regulators in Washington DC on Tuesday to express concerns about the negative effects associated with the increase in trading taking place away from public exchanges.

Representatives at the exchanges confirmed NYSE Euronext's Duncan Niederauer, Nasdaq OMX Group Inc's Robert Greifeld and BATS Global Markets' Joseph Ratterman met with officials from the Securities and Exchange Commission, but would not comment further.

The meetings highlight a growing sense of urgency at the exchanges about the increasing amount of trading by-passing their venues and going instead to so-called "dark pools" and "internalizers," said a person at one of the exchanges, who did not have permission to speak to the media.

"Dark pools" are trading platforms where buyers and sellers of stocks remain anonymous and their orders are hidden until they are executed. "Internalizers" are brokers that match orders within their own firms, allowing them to avoid exchange fees.

The exchanges have long argued that the rise of off-exchange trading distorts prices in the public markets and makes the markets in general less transparent.

The practice also affects their bottom lines.

"The numbers are pushing them to want to refocus regulatory attention," said SEC Commissioner Dan Gallagher. "If you look at the market share of the exchanges, the numbers are at all time lows."

Gallagher said the exchange CEOs were talking with individual commissioners in a series of meetings and he planned to meet with Greifeld and Ratterman.

Off-exchange venues, not including electronic communication networks, made up 38 percent of U.S. trading volume in February, according to data from research firm Tabb Group.


Dark pools do appear to reduce liquidity and increase trading costs on the public markets, said Craig Pirrong, a finance professor at the University of Houston.

But the competition dark pools provide to exchanges has the effect of keeping trading costs in check and costs could be higher without that.

"It not a matter of black and white - or of dark and light, if you will," he added.

There are around 50 dark pools in the United States and 13 public exchanges. Some of the largest U.S. dark pools are run by banks that are also some of the exchanges' largest customers. They include Credit Suisse Group AG's CrossFinder, Morgan Stanley's MS Pool and Citigroup Inc's Citi Match.

Credit Suisse and Morgan Stanley declined to comment, while a Citi spokesman was not immediately available.

Incoming SEC Chairman Mary Jo White said in her Senate confirmation hearing on March 12 that the agency should continue to explore the effects of dark pools, along with other issues, such as high-frequency trading and the proliferation of order types on exchanges.

White, a lawyer and former federal prosecutor, was a director on Nasdaq's board from May 2002 until February 2006.

Regulators in Australia proposed new rules last month that would create a minimum threshold for orders in dark pools and improve disclosure and supervision of off-exchange trading.

And in Canada, new rules took effect last October setting minimum sizes for dark orders that do not give a significantly better price than public exchanges. The market share of dark pools in Canada hit a record of 5.8 percent in August last year, but dropped to 2.1 percent a month after the new rules were introduced and stood at around 2 percent in February, according to data from Rosenblatt Securities.

"What they are trying to do is to get dark pools to go back to the reason they were formed in the first place," said Seth Merrin, CEO of dark pool operator Liquidnet, which has operations in the United States, Canada, Europe and Asia.

Dark pools were originally meant for institutional investors looking to buy or sell large blocks of shares without tipping their hand to the wider market, which could trade against their positions. But the average size of orders now being traded in dark pools in February was just over 200 shares, in line with public exchanges, according to Rosenblatt.

The result of smaller transactions spread across 50 venues is that retail investors end up with shallower public markets, making it harder for them to get trades executed, said Merrin.

He would like to see the SEC follow Canada and Australia's lead on dark pool regulation.

"We are at this point, lagging the other regulators around the world in doing something about this," he said.

Liquidnet's average execution size is 44,000 shares.

(Reporting By John McCrank. Editing by Andre Grenon)