Healthy Markets on Dark Pools with Sen. Warner

Markets Association

Dark Side of the Pools: What Investors Should Learn From Regulators’ Actions

September 15, 2015  

Topics & Takeaways 

  • Consolidated
    Audit Trail (CAT):
    Sen. Mark Warner (D-Va.) and Tyler Gellash,
    Executive Director of the Healthy Markets Association, both called for
    expediting the CAT development process to provide more comprehensive data
    about order routing and execution practices in dark pools and
  • Maker-taker
    Warner maintained that maker-taker rebates induce firms
    to execute orders according to the rebate policy, instead of where they
    can gain the best price for investors, as required by law. Senator Warner
    also claimed that such rebates may lead to market disruption.
  • Tick-Size
    Senator Warner claimed policymakers should continue to
    prioritize the tick size pilot to improve market making for small caps
    which are less appealing for HFTs. 


Introduction to Healthy Markets Association

Dave Lauer, Chairman, Healthy
Markets Association

explained that the Healthy Markets Association will aim to promote data and
analysis for institutional investors, as well as advocate for market structure
reform.  Lauer conveyed the Healthy Markets Associations’ priorities,
which include:

  • Developing robust and comprehensive ATS disclosure standards;
  • Pushing to modernize rules 605 and 606 (regarding order routing and best execution);
  • Illuminating rebates; and
  • Eliminating speed disparities between public SIPs and private market data providers.

Tyler Gellash, Executive Director,
Healthy Markets Association

conveyed that the increased demand for dark pools demonstrates that they are
essential for investors to execute orders, but expressed concern that dark
pools are “black boxes” and investors do not understand how they work.

summarized several recent cases of regulatory enforcement against dark pool
operators, including Pipeline, Barclays, UBS, and ITG. While he noted that
regulatory scrutiny of and enforcement against dark pool operators is
increasing, he still claimed that “any dark pool is a risk” for similar bad
practices. Gellash noted that regulators’ focus has been centered on disclosure
requirements, but said that investors need more than disclosure to protect
themselves against misconduct.  He concluded that investors cannot rely on
regulatory efforts alone and must better inform themselves about how their
orders are handled, routed and executed. He also encouraged market participants
to consider whether current order routing and execution decisions run counter
to financial institutions’ fiduciary duties.

Senator Mark Warner (D-Va.)

Warner commended the Healthy Markets Association on its efforts to help
policymakers understand how markets function, how they can be improved, and how
they can enhance transparency. Warner noted several movements in regulatory
reform, citing three recent Securities and Exchange Commission (SEC) actions
related to dark pools, and shared that he believes the Dodd-Frank Act can be

claimed that, for the most part, U.S. equities markets provide good execution
prices for investors on both sides of the trade, but highlighted a chart
indicating that intraday price volatility in U.S. equities markets has
increased five-fold since 1996.  He argued this increased volatility costs
investors between $6-10 billion annually.

summarized several reported causes of equities market volatility, including
structural market changes, technological advancements and electronification of
markets, which have lead to several flash crashes or glitches at stock
exchanges.  Warner shared that, while he claims to be a ‘free markets
advocate,’ he doesn’t buy the argument that high frequency trading (HFT) and
dark pools are unambiguously positive developments solely because they increase
market liquidity.  He claimed that the liquidity argument is “too
simplistic,” and can be used to “cover up […] bad actors.”  Warner argued
that policymakers must consider the point at which HFT and dark pools lead to
an inherent conflict with fairness in markets.

Warner claimed that while most attention has been focused on U.S. equities
markets, the public must be mindful that the U.S. Treasury market is the most
liquid in the world, but that events on October 15, 2014 clearly indicated that
“something is happening.”  He also expressed concern that some primary
market makers reportedly turned off their computers during the market gyrations
on October 15th, and argued that doing so “might not be the best
response” to stress events. Warner claimed that he finds the argument that
these market volatility events stem from Dodd-Frank reforms “questionable.”

recalled the hearings held last Congress by Senator Carl Levin (D-Mich.) on maker-taker rebates and claimed these rebates induce firms
to execute orders according to the rebate payments, instead of where they can
gain the best price for investors, as required by law. Warner also claimed that
such rebates may lead to market disruption.

closed his remarks by providing several recommendations, including urging
policymakers and market participants to:

  1. Develop
    additional data to be better informed about how markets work;
  2. Prioritize
    the tick size pilot to improve market making for
    small cap stocks as well as exploring additional pilots to help
    policymakers and the public learn about market
  3. Increase
    the number of exchanges to offer opportunities for new entrants to compete
    on transparency, stating that the “best disinfectant could be more
  4. Expedite
    the Consolidated Audit Trail (CAT) to enable policymakers
    and regulators to see whether market manipulation is occurring, stating
    that while the CAT would not be a “silver bullet,” it is desperately
    needed, and that he intends to push SEC Chair White to ensure this is a
    priority going forward; and
  5. Recognize
    that debate on healthy markets should be bi-partisan.

Question & Answer

audience member inquired why everyday investors should be concerned about dark
pool abuses.  Senator Warner responded that the core issue is about
transparency and noted that not all investors and market participants have
access to the same information.  In the aggregate, he said, this has
enormous economic consequences.

member from the audience asked what’s happening on Capitol Hill with regard to
improving the financial market regulatory structure. Warner noted that earlier
drafts of Dodd-Frank would have instituted a more streamlined, simpler
regulatory structure, which would have merged the Commodity Futures Trading
Commission (CFTC) and SEC.  While Warner maintained that the CFTC and SEC
should be a single entity, he explained that there are no current efforts on
the Hill to restructure regulators.

participant noted that dark pools are international and inquired whether it
would make sense to take a global approach to regulation. Warner agreed that it
would, indeed, make sense to take an international approach to regulating dark
pools, however he expressed that the U.S. should not wait for other countries
(such as Europe) to take action, because it would slow down needed reforms. He
also conveyed that it is not the intent or reforms to push capital and dark
pools to other jurisdictions.

asked to comment on recent regulatory action against dark pool operators,
Warner claimed he hopes that policymakers can build on recent regulatory
actions to provide policy guidance to the market.

was then asked whether the CAT has been delayed due to market participants’
incentive to prolong the process since they would ultimately be subject to
regulatory scrutiny.  Warner stressed that more leadership from the SEC is
needed on this issue.  He also expressed disappointment in the progress of
the Office of Financial Research (OFR), saying it should serve as a neutral,
independent entity to aggregate data from market participants and other

final question from the audience was whether dark pools should be regulated as
exchanges to level the playing field between the two.  Warner noted that
the SEC is taking regulatory action, new exchanges are coming online to address
mixed incentives that come from dark pools, and that more focused regulatory or
congressional action is needed. However, he denied that the best policy prescription
would be to regulate dark pools as exchanges.


shared the Healthy Markets Association’s recommendations for institutional
investors dealing with dark pools, including:

  1. Developing
    a transparency best practice guide to address conflicts of interest, smart
    order routing practices, and best execution.
  2. Enhancing
    data availability to allow investors to independently verify or audit the
    order routing and execution practices of dark pools and avoid or mitigate
    conflicts of interest
  3. Encouraging
    investors to utilize venues that have a good execution policy or who are
    less conflicted.

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