Dark Pools
Palgrave Macmillan Finance and Capital Markets Series For information about other titles in this series please visit the website http://www.palgrave.com/business/finance and capital markets.asp Also by Erik Banks: THE PALGRAVE MACMILLAN DICTIONARY OF FINANCE, INVESTMENT AND BANKING RISK AND FINANCIAL CATASTROPHE THE CREDIT RISK OF COMPLEX DERIVATIVES, THIRD EDITION LIQUIDITY RISK CORPORATE GOVERNANCE THE FAILURE OF WALL STREET WORKING THE STREET WEATHER RISK MANAGEMENT ASIA PACIFIC DERIVATIVES MARKETS EMERGING ASIAN FIXED INCOME MARKETS THE CREDIT RISK OF FINANCIAL INSTRUMENTS
Dark Pools The Structure and Future of Off-Exchange Trading and Liquidity ERIK BANKS
Erik Banks 2010 Softcover reprint of the hardcover 1st edition 2010 978-0-230-23810-7 All rights reserved. No reproduction, copy or transmission of this publication may be made without written permission. No portion of this publication may be reproduced, copied or transmitted save with written permission or in accordance with the provisions of the Copyright, Designs and Patents Act 1988, or under the terms of any licence permitting limited copying issued by the Copyright Licensing Agency, Saffron House, 6-10 Kirby Street, London EC1N 8TS. Any person who does any unauthorized act in relation to this publication may be liable to criminal prosecution and civil claims for damages. The author has asserted his right to be identified as the author of this work in accordance with the Copyright, Designs and Patents Act 1988. First published 2010 by PALGRAVE MACMILLAN Palgrave Macmillan in the UK is an imprint of Macmillan Publishers Limited, registered in England, company number 785998, of Houndmills, Basingstoke, Hampshire RG21 6XS. Palgrave Macmillan in the US is a division of St Martin s Press LLC, 175 Fifth Avenue, New York, NY 10010. Palgrave Macmillan is the global academic imprint of the above companies and has companies and representatives throughout the world. Palgrave and Macmillan are registered trademarks in the United States, the United Kingdom, Europe and other countries. ISBN 978-1-349-31528-4 DOI 10.1057/9780230275218 ISBN 978-0-230-27521-8 (ebook) This book is printed on paper suitable for recycling and made from fully managed and sustained forest sources. Logging, pulping and manufacturing processes are expected to conform to the environmental regulations of the country of origin. A catalogue record for this book is available from the British Library. A catalog record for this book is available from the Library of Congress. 10 9 8 7 6 5 4 3 2 1 19 18 17 16 15 14 13 12 11 10
Contents List of Illustrations Acknowledgments About the Author vii ix x PART I MARKET STRUCTURE 1 Introduction to Dark Pools 3 2 Market Liquidity and Structure 30 3 Dark Pool Structure 57 PART II MICRO ISSUES 4 Topics in Pricing and Execution 93 5 Trading in Dark Pools 115 6 Aspects of Technology and Architecture 136 PART III ENVIRONMENT OF THE FUTURE 7 Regulation, Control, and Transparency 163 8 The Future of Dark Pools 183 v
vi CONTENTS Appendix 1 Listing of Dark Pool Sites 199 Appendix 2 Listing of MiFID Regulated Markets, Systematic Internalizers, and Multilateral Trading Facilities 201 Notes 206 Selected Bibliography 213 Glossary 215 Index 225
Illustrations FIGURES 1.1 Orders coming into various price points 15 1.2 Sources of dark liquidity 19 2.1 Limit bids and offers 37 2.2 Reserve order execution in Stock XYZ 42 2.3 Hidden order execution in Stock XYZ 43 2.4 Order types 45 2.5 Market structures 52 2.6 Liquidity spectrum 56 3.1 Types of alternative trading systems/multilateral trading facilities 65 3.2 Key types of crossing networks 74 3.3 Broker/dealer desk model 76 3.4 Examples of dark pool venues and mechanisms 85 4.1(a) Limit order book: Stock XYZ 97 4.1(b) Limit order book: Stock ABC 98 4.2 Supply, demand, and market clearing price 100 4.3 Crossing at best bid offer 104 4.4 Order entry into a crossing network 107 5.1 Implementation shortfall routine 130 6.1 Trade lifecycle 143 6.2 Routing process 148 6.3 The matching flow 153 7.1 Fidessa dark/light trade activity screens 176 vii
viii ILLUSTRATIONS TABLES 1.1 Sample U.S. exchange matched market share performance, August 2009 27 1.2 Sample U.S. off-exchange matched market share performance, August 2009 28 1.3 Sample European exchange matched market share performance, August 2009 28 1.4 Sample European off-exchange matched market share performance, August 2009 28 2.1 Major classes of orders and primary motivations 45 2.2 Stock EFG order book example 1 46 2.3 Stock EFG order book example 2 46 2.4 Stock EFG order book example 1, without illustrating the dark trade 47 3.1 Major global exchanges with hidden/reserve orders 60 4.1 Stock ABC order book, pre-call 100 4.2 Stock ABC order matching 101 4.3 Stock ABC order book, post-call 101 4.4 Stock ABC, continuous-order market 102 4.5 Top 10 fragmented stocks on the FTSE 100, August 2009 110 6.1 Share blocks on various dark pools 150 6.2 Order fill against various dark pools 150 6.3(a) FOK buy limit order at $50.00, 1000 shares 158 6.3(b) Dark sell peg order at the midpoint of the NBBO, 2000 shares and minimum quantity 1000 shares, valid market open tomorrow (T + 1) 159
Acknowledgments I would like to extend my thanks and appreciation to Lisa von Fircks at Palgrave Macmillan for her support in yet another project. Credit is also due to Renée Takken and the editing, production, and marketing teams at Palgrave Macmillan for their work in producing the book. Valuable input was provided by Steve Grob at Fidessa and several referees at Goldman Sachs, JP Morgan, and NYSE Euronext, and I am grateful to all of them for helping improve aspects of the book. And, as always, my biggest thanks to Milena. EB ix
About the Author Erik Banks is responsible for risk management of the Corporate and Investment Banking division at the European universal bank, UniCredit. Over the past 23 years he has held senior risk positions at Citibank, Merrill Lynch and in the hedge fund sector, in New York, Tokyo, Hong Kong, London, and Munich. He is the author of more than 20 books on risk, derivatives, emerging markets, and governance. x