Dark pools’ lifeguard

July 7, 2014

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“Insider Trading 2.0,” New York attorney general Eric Schneiderman’s war on high-frequency trading abuses, wages on. At the end of June, Schneiderman filed a complaint against Barclays over the activity of the firm’s dark pool, Barclays LX, which is the second-most active alternative trading system in the United States. Schneiderman is accusing Barclays of fraud, suggesting that instead of protecting investors in the dark pool from high-frequency traders (as advertised), the firm did the opposite, and actually “operated its dark pool to favor high frequency traders.”

A dark pool is a non-public place to trade, which is advantageous for big institutional clients because they can buy and sell in large blocks without the transparency of public exchanges. Big investors see this as a good thing, because they can trade without the interference of high-speed trading firms that have the ability to affect the price of the trade between the time a trade order is announced and when it is executed. (Here’s a longer explanation). According to Schneiderman, Barclays sold this narrative to institutional investors to get them to trade on Barclays LX. It then also invited HFT firms into the dark pool, and, to add insult to injury, charged the HFT firms lower fees than their other clients.

“Barclays was lying to customers. They weren’t protecting them — they were setting them up,” Columbia securities law professor John Coffee tells the New York Times. The larger worry, writes Matthew Phillips, is that if this sort of behavior is normal in other dark pools, this makes them “pretty much the exact opposite of what they claim to be.” In a story that includes the words “market structure nightmare” in the headline, Bloomberg’s Sam Mamudi and Doni Bloomfield write that “the action provided ammunition to those who say the stock market’s opaque structure mainly serves insiders.” After the complaint was filed, add Mamudi and Bloomfield, a number of institutional investors left the platform.

On the other hand, Matt Levine says that without HFT, there simply wouldn’t be a lot of trading in dark pools. “You can run a pristine dark pool without ‘predatory’ high frequency traders, and without much trading, or you can run a useful dark pool with high-frequency traders,” he writes. Regardless of the reason, Dominic Elliott says it is important to remember that “the growth of commoditised, electronic platforms has made [equity trading] less profitable,” and “dark pools may be one of the few lucrative areas left,” which is likely why Barclays moved so aggressively to grow its own.

Finally, this is perhaps neither here nor there (but still a wonderful twist): back in February, Barclays LX was awarded the title of “Best Dark Pool” at the Markets Choice Awards. Barclays’ head of equities electronic trading, Bill White, said at the time: “For us, the biggest theme of the year was transparency. It was an important topic throughout the year, and it remains a core element of our strategy.” — Shane Ferro

On to today’s links:

Dollar Bills
Post-BNP settlement, the French would like a little bit less global reliance on the dollar – FT

A crackdown on international money laundering also threatens legal remittances – NYT

“Monetary policy can’t halt the violence in Iraq or make it rain in California” – Bill McBride

Sovereign Debt Problems
Argentina’s “little vultures” – WSJ

“Economic entropy (money) is directly linked to thermodynamic entropy which is equivalent to information entropy” – David Galbraith
The case for more apprenticeships – Timothy Taylor

Truck drivers at the ports of LA and Long Beach are on strike indefinitely – Ned Resnikoff

Easing Ain’t Easy
There have been lots of failures in the repo market lately, possibly connected to QE – Liz Capo McCormick

The cell phone battery revolution we’ve all been waiting for… is still a few years off – Kevin Roose

Stuff We’re Not Linking To
The college dropout behind NYC’s most exclusive credit card

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