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SEC proposes dark pool rules; institutions divided over merits of high frequency trading

21 October 2009  |  6328 views  |  0 Financial numbers

The US Securities and Exchange Commission has unveiled proposals aimed at shedding more light on dark pool trading by introducing new rules that would require enhanced public disclosure of stocks passing over alternative trading networks.

At an open meeting in Washington, the Commission is presenting three specific measures aimed at strengthening the regulation of dark pools and increasing market transparency.

The first proposal would require actionable indications of interest (IOIs) to be treated like other quotes and subject to the same disclosure rules. The SEC is also proposing to lower the trading volume threshold applicable for displaying best-priced orders in a particular stock from the current five per cent level to 0.25%. A third proposal on the table would amend existing rules to require real-time disclosure of the identity of the dark pool that executed the trade.

Introducing the proposals, SEC chairman Mary Schapiro says: "Although dark liquidity always has existed in one form or another in the equity markets, the Commission must assure that the public markets and non-public trading venues operate within a balanced regulatory framework."

The SEC has already said that it intends to ban flash trading - which gives some investors a sneak peak at open order before the wider market - and undertake a review of high frequency trading practices, including co0location and direct market access.

The latest move comes as Greenwich Associates releases research which implies that institutional investors are deeply divided over the merits or otherwise of high frequency trading strategies. Much of the support for further regulation is centred around the use of flash orders and indications of interest that are widely seen as elements of front-running.

However, interviews with 78 institutional investors in Canada, the US and Europe found that even some of the most active institutional stock traders cannot agree about whether high-frequency trading helps or hurts institutions, retail investors and the companies with publicly trading stock.

Forty-five percent of participating institutions think high-frequency trading poses a threat to the current market structure, while 36% believe it actually benefits the market and investors by increasing overall liquidity. However, almost 20% of institutions say they do not know enough about high-frequency trading to make a judgment about its overall impact on the market, much less on specific stock prices.

"Institutions are even split about whether high-frequency trading helps or hurts their own trading operations and outcomes," says Greenwich principal Jay Bennett.

Until these questions are answered, regulators should limit any new rules to narrow trading practices that have an obvious and proven negative impact on investors, he says.

"More specifically, we would urge the SEC to commission an academic study on the short-term and mid-term effects of high-frequency trading on a company's stock: opinion is evenly divided as to prospective benefits vs. negatives, with fully half of institutional investors claiming uncertainty."

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