South Africa’s JSE Ltd (www.jse.co.za) this week announced that it was close to creating Africa’s first “dark pool” for trading large orders. These are structures that allow bidders to post and transact very large orders or block orders without disrupting the market, for instance prices and volumes may not be revealed publicly before the trade but only get posted after the event.
The Financial Times (www.ft.com) quotes the JSE’s Head of Equity Market Leanne Parsons as saying the JSE’s facility will be called Block X and was the exchange’s “response to market demand when trading in large volumes”.
“Our large users have made it clear to us that while the transparent central order book has numerous advantages, they would also like hidden-order functionality. This is offered in other markets which offer trading in JSE-listed securities,” she said, referring to multilateral trading facilities (MTFs) such as Chi-X, BATS Europe, Nasdaq OMX Europe and Turquoise
Ms Parsons added: “As competitive pressure in the exchange environment builds, innovation becomes increasingly important.”
Worldwide exchanges found recently that the average order size has fallen by 52%, caused by high frequency and automated or algorithmic trading. Last month the JSE changed its fee structure “to recognise both low-value and high-volume traders”.
However, for many years banks and brokers have set up their own dark pools, for instance initially calling each other when clients have large orders or significant stakes in a company so that the market would not start to move share prices up or down in response. Prices and trades may or may not be revealed after the trade, and some of the trades would bypass a stock exchange entirely. This has led to the development over the years of trading systems on or off the major exchanges.
According to a presentation that JSE CEO Russell Loubser prepared for the World Federation of Exchanges (www.world-exchanges.org) in October 2009, their survey of major exchanges that had or had not introduced these facilities found that main reasons for setting up or intending to set up such a facility were: Mitigate market impact of large trades; provide confidentiality or trading anonymity; improve liquidity levels; cost efficiency; new regulations (MiFID); adding value; avoiding defragmented market; and others. Those that did not want to set itup responded that they were concerned about additional fragmentation; do not see the benefits; or have market mechanisms not suited for dark pool offering.
Dark Pools represent less than 10% of trade volume on the European equity shares market. According to Mr Loubser, in the US the figure was closer to 14% of equity trading volume.
Two years ago the EU Markets in Financial Instruments Directive (MIFID), came into force. It allowed for the opening up of new trading systems, particularly in the equities market (see helpful background on The Official Board website www.theofficialboard.com). In order to ensure market transparency and integrity this Directive establishes pre-trade and post-trade transparency requirements. For example, the directive’s pre-trade transparency requirements include the obligation to make public on a continuous basis current bid and offer prices and the depth of trading interests at these prices during a continuous basis during trading hours.
However, MIFID allows for the waiver of these obligations for transactions that are large in scale compared to normal market size. The aim is to prevent the acquisition or transfer of a large number of shares from triggering a large increase or decrease in share prices if this order were made public. This has spurred the development of dark pools for block trades, i.e. trading systems that operate without pre-trade transparency.
In the second half of last year there has been increasing debate and regulatory discussions about the impact of dark pools on major world markets.