Should dark pools be prohibited? Discuss this statement by exclusively presenting arguments that this is not the case.
A dark pool is defined by Banks (2010) as an alternative trading system for the anonymous trade of standardised financial products. Pan (2017) specifies it as mainly an equity trading venue. The trades in a dark pool are, according to Ye (2016), concluded outside of any display order. This differs from lit markets, such as traditional stock exchanges, as the trade, according to Comerton-Forde and Putniņš (2015), is only made public after it has been executed. Dark pools are a highly unregulated market sector and not subjected to the rules and regulations of the European stock exchanges, as Baxter (2017) highlights. Petrescu and Wedow (2017) therefore assumed that the key feature of dark pools is less transparency compared to lit markets, i.e. market participants do not have an overview of the supply and demand of the products. The traders purchase and sell on dark pools without showing their identities or exposing transactions to the public market; therefore, the available liquidity in the dark pool is anonymous, as pointed out by Kratz and Schöneborn (2014). The price of a successful order is calculated, as claimed by Banks (2014), as the midpoint of the bid and offer. Zhu (2014) states that the execution of an order in a dark pool is not guaranteed, unlike the traditional stock exchange.
Table of Contents
1. Definition and Characteristics of Dark Pools
2. Arguments Against the Prohibition of Dark Pools
2.1 Advantage of Reduced Transparency
2.2 Lower Trading Costs and Market Efficiency
3. Conclusion
Objectives and Topics
This paper examines the role of dark pools in modern financial markets, specifically addressing the debate over whether they should be prohibited. The research concludes that dark pools should remain operational as they offer distinct advantages to market participants and support overall market quality.
- Functional definition and characteristics of alternative trading systems
- Benefits of delayed public disclosure for institutional trading strategies
- Reduction of transaction costs and price impact for large block orders
- The role of competition between lit markets and dark pools
- Impact of dark trading on overall market quality and price discovery
Excerpt from the Book
The second advantage of dark pools, as pointed out by Aubrey (2009), is the lower trading fees compared to traditional exchange charges, also known as direct costs. Davies and Sirri (2017) outline how investors have never before had such low trading costs. For example, investors at the London Stock Exchange (2017a) have to pay 0.45 basis points variable trading fees for an equity exchange of up to GBP 2.5 billion. On the other hand, they only pay 0.3 basis points variable trading fees, according to London Stock Exchange (2017b), for an equivalent trade on the Dark Pool Turquoise, which is also operated by the London Stock Exchange. This price structure makes cost savings possible while trading GBP 2.5 billion of equities at the cost of GBP 37,500. As found by Crudele (2015), the price decreases as the competition increases. In my view, greater competition is good for every market because of the fair price determination and the avoidance of an oligopoly of the traditional stock exchange. Banks (2010) argues that investors can avoid paying exchange fees while trading on the dark pool. The brokers can preserve more of the spread and split the savings with their clients. All participants can strive with this behaviour, according to the Pareto optimality state where everyone gets better and no one gets worse, as pointed out by Cowell (1993). Karstadt (2011) suggests that trading large quantities of stock is more cost effective for the investor on the dark pool. Crisafi and Macrina (2016) justify this with the price determination of the execution, which is the midpoint between the bid and the asking price compared to other markets. These price determinations can save, according to Preece and Rosov (2014), the respective counterparties from exchange fees and half the bid-offer spread. In my view, the execution price in a dark pool should match without exceeding the National Best Bid and Offer to be attractive. This is only possible if the broker gives a discount, even if it is marginal.
Summary of Chapters
1. Definition and Characteristics of Dark Pools: This chapter provides the theoretical foundation by defining dark pools as anonymous, alternative trading systems that operate outside of public display orders.
2. Arguments Against the Prohibition of Dark Pools: This section presents the core analysis, detailing how reduced transparency benefits institutional investors and how cost structures in dark pools improve economic efficiency.
3. Conclusion: The final section synthesizes the evidence to argue that dark pools provide essential market functions and are not detrimental to overall market quality.
Keywords
Dark pools, market quality, financial markets, transparency, trading costs, liquidity, price discovery, institutional investors, lit markets, block orders, competition, equity trading, trading strategies, MiFID II, market participants.
Frequently Asked Questions
What is the primary scope of this document?
This document explores the controversy surrounding dark pools in financial markets, arguing specifically against their prohibition by highlighting their functional benefits.
What are the central thematic fields addressed?
The work focuses on market structure, the trade-off between transparency and liquidity, execution costs, and the competitive dynamics between dark pools and traditional lit exchanges.
What is the core research question or objective?
The objective is to evaluate the statement that "dark pools should be prohibited" by presenting exclusively supportive arguments for why they should remain as active participants in the financial system.
Which academic approach is applied here?
The paper utilizes a literature-based argumentation approach, synthesizing research findings from financial academic papers and regulatory documentation to build a case for dark pool utility.
What content is covered in the main body?
The main body examines the definitions of dark pools, the benefits of delayed public disclosure for large trades, and the comparative cost-efficiency of dark pool trading versus traditional exchanges.
Which keywords best characterize this research?
The core keywords include dark pools, market quality, liquidity, trading costs, price discovery, and institutional trading.
How do dark pools help in managing large block orders?
Dark pools allow for execution without alerting competitors or immediate public disclosure, which prevents the significant price impact that often occurs when large orders are placed on public limit order books.
Why are lower trading fees in dark pools significant for market quality?
Lower fees foster competition, which discourages the development of monopolistic pricing by traditional stock exchanges and aligns with the concept of Pareto optimality where participants can execute trades more efficiently.
Does the author believe dark pools harm price discovery?
No, the author concludes that dark pools coexist with lit markets and serve specific market needs, suggesting that they are not detrimental to the overall price discovery process.
- Citation du texte
- Moritz Meyer (Auteur), 2017, Should dark pools be prohibited?, Munich, GRIN Verlag, https://www.grin.com/document/426430
