Will said it was often used for dilution, Ive seen them on the bid before with huge blocks..
thought this was interesting, talks little about ARCA and how computerized trading has changed things.
guessing these dark pools are in the habit of making money, not losing it.. and explains a lot of mm's actions imo..
Power shifts from trading floor to brokers December 5, 2006
By Edgar Ortega and Yalman Onaran
The biggest customers of the New York Stock Exchange (NYSE) and Nasdaq stock market are turning into their most dangerous competitors.
Securities firms, led by UBS, Goldman Sachs and Credit Suisse, already steer 12 percent of US stock trades away from the exchanges to their internal systems.
That share would probably increase to 18 percent by 2010, as more investment banks bypass the NYSE and Nasdaq and pair buyers and sellers of stock themselves, according to Boston-based Aite Group, a brokerage industry consultant.
Now that computers have eliminated the need for trading floors such as the Big Board's, the balance of power in equity markets is shifting. By bringing more orders in-house, where clients can move big blocks of stock anonymously, brokers pay the exchanges less in fees and capture a bigger share of the $11 billion (R80 billion) a year that institutional investors pay in trading commissions.
"More internal flow gives you a bigger chance to get more trades for your customer or for yourself," said Larry Leibowitz, UBS's chief operating officer for US equities.
"Less transparency could increase the value of the liquidity that a broker has, since nobody else can see it."
Because most bids and offers are shown on the NYSE and Nasdaq, trading on either exchange is akin to playing poker with an open hand. That's why money managers who don't want to expose their strategies are sending more trades to so-called dark pools, the internal or private networks where prices are secret.
Evergreen Investment Management used computer-driven algorithms to automatically pick the routes for 15 percent of its orders, said Bob O'Brien, the head of equity trading at the Boston-based firm. As a result, many never reached the NYSE or Nasdaq.
"We have a lot of the tools now to access the different pools of liquidity," said O'Brien. "In the past, there was the concern that you would have to send an order in 20 different directions to tap into all the liquidity available."
Aite Group estimated that algorithmic trading, which disguised orders to buy stocks at the best possible prices on multiple markets, would account for more than 50 percent of all shares that change hands in the US by 2010, up from about a third today.
Almost every major Wall Street firm operates an electronic trading system that takes incoming trades from clients and finds a match internally before turning to other brokers, electronic networks or the exchanges. UBS calls it Direct Strategy Access. Goldman's answer is Rediplus. Morgan Stanley has Passport and Lehman Brothers calls it Electronic Trading Services.
Credit Suisse, Switzerland's second-biggest bank after UBS, operated one of the largest dark pools, called CrossFinder, said Sandler O'Neill & Partners analyst Richard Repetto.
Instead of building its own system to offer clients anonymous block trades, Merrill Lynch formed a joint venture with New York's Investment Technology Group, whose 19-year-old Posit system was one of the first dark pools.
For every trade they match off the NYSE, brokers save 2.75c per 100 shares, or about 1 percent of the average commission on a stock trade. Last week, the NYSE raised transaction fees from 2.5c per 100 shares and eliminated a $750 000 monthly cap.
As a result, Goldman, the biggest trader on the Big Board, faces an annual bill of about $20 million in NYSE transaction fees, based on its average volume for the first 11 months of the year. Under the old cap, Goldman paid a maximum of $9 million.
At current rates, the top stock brokers by volume will pay about $90 million a year to the NYSE and Nasdaq, based on trading data reported by the exchanges.
"You are going to be more profitable if you have your own internal pool of liquidity to take a bid or an offer in milliseconds without going to the exchanges," said David Mortimer, a principal at Vodia, an industry consulting firm.
"You're getting paid something for the trade, instead of paying the exchanges, and you're faster than anybody else. What better way to lower your execution costs for proprietary trading?"
While Nasdaq and NYSE Group, the owner of the New York Stock Exchange, complete about 75 percent of the almost 5 billion shares a day that change hands in the US, their dominance is slipping. In October, securities firms internalised 16 percent of all trades in NYSE-listed stocks, up from 13.2 percent a year earlier and 11.5 percent in October 2004.
The shift accelerated after the NYSE acquired Archipelago in March, becoming a for-profit company and gaining the all-electronic Arca exchange. The advent of computerised trading forced the Big Board to give up the advantage it once held when all orders for NYSE-listed stocks went through its Lower Manhattan trading floor.
In October, the exchange lifted restrictions on electronic orders and automated many of the tasks performed by its 2 500 traders.
Bloomberg Tradebook and closely held markets such as Liquidnet also compete with the exchanges and Wall Street for stock orders.
Three years ago, before the controversy over former chairman Richard Grasso's pay forced the NYSE to overhaul its corporate governance, the chief executives of New York's largest firms were on the exchange's board. Now they're taking business away from the NYSE.
In Europe on November 15, Citigroup, Goldman, Deutsche Bank, Merrill, UBS, Morgan Stanley and Credit Suisse said they were forming an equity trading platform to challenge traditional bourses.
NYSE Group chief executive John Thain addressed the Wall Street threat in comments to reporters in October at the Foreign Press Center. Thain was unavailable to comment for this story, said spokesperson Richard Adamonis.
"The increasing number of trading venues, as well as internalisation, are the two main risks," he said. "So far the dark pools haven't provided that much liquidity, but they're growing. There are today probably 20 places where you can send an order for NYSE-listed stocks."
Investors still consider NYSE Group's prospects good - the company's shares have gained 50 percent since it went public by acquiring Archipelago in March. Even though the exchange is losing business to the securities firms, it is benefiting from a surge in equity trading and Thain's push to get into new, faster-growing markets.
Trading volume at NYSE Group rose 13 percent in the past 12 months to 2.3 billion shares a day. JPMorgan analyst Ken Worthington expected the exchange's new fees to fuel earnings growth. The number of options contracts traded on the NYSE Arca electronic market climbed 44 percent in the same period.
Thain is poised to complete the $14 billion purchase of Paris-based Euronext, creating the first transatlantic stock market and strengthening the Big Board's allure as a listing venue for the world's largest companies.
The deal would also make NYSE Group the owner of Europe's second-largest futures market, Euronext.Liffe.
Nasdaq chief executive Robert Greifeld is trying to expand overseas. Last month, Nasdaq offered to buy the 71 percent in London Stock Exchange it doesn't already own for about Â£1.9 billion (R17 billion.)
At Nasdaq, which has been all-electronic since its founding in 1971, the percentage of internalised trades has remained steady at about 30 percent over the past two years, because there's no barrier for brokers to compete on equal footing with the exchange.
While the practice of internalisation, or filling one client's order to buy shares with another's to sell, dates back to the NYSE's founding in 1792, it is growing more popular as fund managers hold larger blocks of stock.
Anonymous trades on systems where all orders were handled off the exchanges allowed such investors to buy and sell quickly, without causing a move in prices that could cut the profit or exacerbate the loss, said Michael Bleich, Lehman's head of liquidity strategy.
NYSE and Nasdaq face another threat from Wall Street. Most of the firms that focus on internalisation to boost profits in equity trading have spent more than $160 million combined to acquire stakes in rival exchanges in the past two years.
Goldman, Bank of America, Bear Stearns and E*Trade Financial invested $20 million in the Chicago Stock Exchange in June.
The next month, UBS, Merrill, Morgan Stanley, Citigroup, Credit Suisse and hedge fund Citadel Investment Group doubled their holding of the Philadelphia Stock Exchange to almost 90 percent.
In October Morgan Stanley and Credit Suisse bought stakes in Bats Trading, an electronic stock market. Bats, which began operating in January, now handles more than 3 percent of the trading in Nasdaq-listed stocks.
Lehman, Merrill, Citigroup, Credit Suisse and Fidelity Investments have acquired 42 percent of the Boston Equities Exchange.
"With the NYSE and Nasdaq being so large, brokers are looking for competition to keep prices lower," said UBS's Leibowitz. - Bloomberg
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