As large institutions utilize exchange traded funds to capture market moves, activity in the so-called dark pool is growing, despite securities exchange incentives to bring liquidity back into the light.
The shares of exchange traded products, which include ETFs and exchange traded notes, that trade outside of an exchange have increased to 34% of average daily share volume from 26% in 2011, reports Ari I. Weinberg for Pensions & Investments.
The increase in volume outside an exchange also coincides with an increased cancel/trade ratio for ETPs relative to stocks. Additionally, most large, highly liquid and well-known products consistently have a large number of share volume trades away from securities exchanges.
Dark pool liquidity refers to the trading volume created by institutional orders that are unavailable to the general public. These so-called dark pools are named for their lack of transparency. The dark pool liquidity is typically comprised of large block trades facilitated by institutional investors who try to weave in and out of the market without significantly impacting the markets with their large orders. As institutional investors take on larger trades, the money managers seek out tight spreads with limited price impact.
However, across the various exchanges, brokers and investors can see a number of order types and routing instructions, which some observers attribute to the SEC Regulation NMS that was designed to improve price and transparency.
In June, Bloomberg Tradebook launched an anonymous request for quote service to help institutional investors find large block ETP liquidity. Over four months, the number of ETPs requested jumped to 71 products from 35 as the number of firms using the platform increased fourfold to 35.
Nevertheless, exchanges are trying to bring these trades back into the light through incentives programs that would compensate market makers for tighter quotes. For instance, the ProShares Managed Futures Strategy (NYSEArca: FUTS) signed up for the incentive program on NYSE Arca, with Jane Street Trading as the lead market maker for FUTS. On the BATS exchange, three ETF issuers are participating in a “competitive liquidity provider” program with four market makers. [A Look at the Cogs and Gears Behind ETF Trades]
For more information on the ETF industry, visit our current affairs category.
Max Chen contributed to this article.