Nasdaq announces own hosted dark pool “Ocean”, SEC calls for transparency

The dark liquidity pool debate opens once again…..

Nasdaq (Nasdaq:NDAQ) has developed its own hosted dark pool, which is being launched under the name Ocean, using its technology, compliance monitoring and operations. In the US, there are 12 public exchanges hosting dark pools along with 40-broker run ones, accounting for nearly 18% of all trading in those stocks in the last two years.

Nasdaq is widely known to not only be an operator of institutional electronic marketplaces, but is also very much an institutional technology provider.

A dark pool is a private forum for trading securities, several such networks having risen to prominence since 2007 with the fragmentation of financial trading venues and electronic trading.

Away from public eyes, large blocks of securities can be traded anonymously until they are filled, avoiding market impact throughout the transaction, allowing high-frequency trade systems to be protected against predatory traders.

On the other hand, by not allowing to see names and sizes of trades made in the dark pool, the concept is purposely nontransparent, which has raised regulatory concerns. By 2009, the US Securities Exchange Commission (SEC) announced it was proposing measures to increase transparency in dark pools. In 2013, FINRA announced it would expand its monitoring of dark pools.

In 2011, the SEC brought an enforcement action against one dark pool operator, Pipeline Trading Systems LLC, that advertised that no proprietary trading was taking place in the dark pool while using unfair informational advantages to front-run subscribers’ trades. The firm later rebranded itself as Aritas Securities LLC. Similar actions were taken against Investment Technology Group (settlement of $20.3 million), UBS (settled to $14.4 million on charges of favoring some customers over others) in January 2015, Barclays and Credit Suisse (settled to $150 million combined).

Seven years after first remarks, regulatory authorities continue unsatisfied with current practices. In late 2015, the SEC said it was considering “much-needed enhancements” to the regime for alternative trading systems (ATS) that trade the national market system (NMS) stocks.

“The proposed changes would represent a critical step forward in delivering greater transparency to investors and enhancing equity market structure”, said SEC Chair Mary Jo White. The proposal would require detailed disclosures about ATS and its operations and the activities of its broker-dealer operator and its affiliates.

“These disclosures would include information regarding trading by the broker-dealer operator and its affiliates on the ATS, the types of orders and market data used on the ATS, and the ATS’ execution and priority procedures.” Disclosures would become publicly available of the SEC website, “which could allow market participants to better evaluate whether to do business with an ATS, as well as to be better informed when evaluating order handling decisions made by their broker.”

The SEC issue with dark pool operators has been against broker-dealers due to the inability to provide a level playing field. “Bereft of regulatory intervention, these market participants seem to be taking matters into their own hands. Nine of the largest asset managers have banded together to form their own dark pool, one that is operated by and open exclusively to institutional investors.”

According to reports, one of the goals of this new “buy-side institutions only” dark pool is to “eliminate the types of profit driven conflicts of interest that have been seen in some existing venues” This action by buy-side investors with approximately $14 trillion in assets under management seems to be a clear warning the markets aren’t working as well as they could, a warning that has gone unheeded for far too long.”, wrote Commissioner Luis A. Aguilar.

Earlier in March, Nasdaq had revealed an agreement to acquire 40% of International Securities Exchange (ISE), one of the world’s largest equity derivatives corporations and owner of a dark pool, from Deutsche Börse Group for $1.1 billion in cash and debt.

The deal is expected to close in 2016 H2 and the transaction to be accretive within 12 months of closing. More than 15% of US options trading is done through ISE’s exchanges. Nasdaq expects to realize a minimum of $40 million in annualized expense synergies within 18 months of the deal closing.

Still in March, Nasdaq made public a deal to buy Boardvantage for $200 million, also funding purchase price through a mix of debt and cash in hand, with no expected material impact on finance leverage nor capital return strategy.