A closer look at dark pool regulation (continued)

"The rise of "pinging"

Another new route likely to be taken by large investors is the use of immediate-or-cancel orders to "ping" potential counterparties. IOCs could be blindly sent to dark pools and other alternative exchanges in the hope of drawing a response or finding a match for an order. According to Traders, the ATS Liquidnet Holdings Inc. has already updated its system to a "pinging" model, whereby IOCs would serve the exact same purpose as IOIs. This is another example of how traders, instead of simply translating their IOIs into quotes on the public market, would simply find another venue for transfering valuable information and lowering the market impact of trades. One drawback to the SEC approach to curving the use of IOIs was that it did not provide an exact definition for the term "actionable IOI," so that traders are allowed some wiggle room in terms of compliance. The potential for the use of IOCs in virtually the exact same capacity as IOIs can be seen as a consequence of this short-fall.

The death of dark pools?

A Reuters article quotes an anonymous dark pool official regarding the SEC's proposal to lower the display threshold for any share from 5 percent of total volume to .25 percent: "That's a very low threshold...you're really just trying to put a lot of dark pools out of business. It's very uncompetitive." The reason for such a drastic reduction in display threshold also has to do with the threat of predatory traders known as "gamers," who use the anonymity provided by dark pools to trade against block share transactions. According to Bloomberg, the SEC decided against a 1 or 2 percent threshold because that would actually benefit predatory traders.

The SEC's goal in lowering the threshold is to drive smaller transactions into national exchanges, thereby increasing market transparency and the accuracy of quoted prices. But this could simply drive away the majority of dark pool customers, putting the ATS market into jeopardy. In another Reuters article, Larry Tabb, chief executive of the TABB Group, said that the SEC proposals "could concievably" wipe out dark pools.

The SEC has invited the public to comment on its proposals, and has acknowledged the need to maintain the necessary advantages dark pools can offer large investors. The deadline for submissions is Monday, Feb. 28. Visit the SEC site to contribute.

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