The allure of outside trading is a growing temptation for clients who want to avoid exchange-trading fees, but a ‘dark pool’ when it comes to the threat to their investments, say some industry experts.
Recent statistics indicate that about 40 per cent of all U.S. stock trades are now happening “off exchange,” compared to just 16 per cent six years ago.
This trend is a concern as the more trading that occurs outside of exchanges, the greater the chance that publicly-quoted stock prices will fail to reflect where the market stands. Critics say the practice is detrimental to the health of the ‘broader’ market, reducing price transparency - counter-productive to the efforts of regulators around the globe - as venues skew the prices of transactions. With $21.4 trillion worth of U.S. stocks traded in 2012, even minor mispricing could cost the market tens of billions of dollars, reported Reuters.
“We have academic data now that suggests that, yes, in fact there is a point beyond which the level of dark trading for particular securities can really erode market quality,” said John Ramsay, former head of the U.S. Securities Exchange Commission (SEC), at a conference in February, reported Reuters.
How does ‘off-exchange’ trading work?
When a share is bought or sold, the trade is typically matched up with another order by a dealer on an alternative to exchanges - what is termed a 'dark pool' - while avoiding exchange-trading fees and reducing the overall cost. Large orders can be disguised reducing the risk of investors being discovered or taken advantage of.
Despite the concern – which has the U.S. Justice Department, the FBI and industry regulators investigating high-speed trading and high-frequency stock traders – these types of firms have seen their revenue decrease from about $5 billion in 2009 to about $1 million in 2013, according to Rosenblatt Securities, reported Reuters.
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