How Dark Pools of Liquidity Work and their effect on the U.S. Financial System
A Presentation by:
John Abbott
Samia Bagdady
Kunal Bavishi
Andre Sanchez
Todd Vivenzio

Background
What are Dark Pools? When Did they Arise?
• Dark Pools of Liquidity are ways that investors/financial
Institutions can hide their orders
• Has existed for a while, just under different names
• “Upstairs Market” at NYSE
• Black Pool
• Alternative Trading System (ATS)
• Crossing Networks
• Became very popular in the 1980’s
• Rise in computer use facilitated “Dark Pool” growth

Background
What are Dark Pools? When Did they Arise?
• Unlike the “Open” NYSE Exchange, “Dark Pools” draw price from market
• “Dark Pools” do not impact the market price
• Details of transactions do not have to be reported to market
• Becoming increasingly popular among Hedge
Funds and Brokerage firms
• Sell large positions anonymously
• Strategic edge over firms that trade large volume in open market

Background
What are Dark Pools? When Did they Arise?
How much are Dark Pools of Liquidity Growing?
Only Comprise 10 % of Equity Trading…
Percent of Total Equity Trading
Transactions (2007)
10%
ATS
Open Market
90%
…but are growing at an enormous rate (40%!)
Growth of "Dark Pools" in Equity
Markets (Projected)
60%
40%
20%
0%
2006 2008 2010 2012 2014

Background
What are Dark Pools? When Did they Arise?
• What are the Main Drivers for “Dark Pool” Growth?
• Main role was to provide a “crossing network” to match sellers/buyers
• Now biggest drivers are…
• Speed Trading
• Algorithms
• “Sharing of Dark Pools”
• Locking out other firms and individual traders…ethical?

Uses of Dark Pools of Liquidity
How are they used? What are their advantages? What are ATSs?
• Normally, equities are exchanged on open markets
• NYSE
• NASDAQ
• This presents several disadvantages to sellers
• “Open Market” = Lack of privacy
• Technical Pressure
• Large # Shares Sold
• Broken into Blocks
• Higher Supply, Lower Price
50,000 shares
10,000 shares
10,000 shares
10,000 shares
10,000 shares
10,000 shares
2$/share
1$/share
Time

Uses of Dark Pools of Liquidity
How are they used? What are their advantages? What are ATSs?
• Dark Pools are Closed Exchanges
• Also called ATS (Alternative Trading System)
• Buyer & Seller = Anonymous
• Don’t have to Break up shares
50,000 shares
10,000 shares
10,000 shares
• As a result, faster trading
• Cheap for sellers! 0.5 - 2¢/share
10,000 shares
10,000 shares
10,000 shares

Uses of Dark Pools of Liquidity
How are they used? What are their advantages? What are ATSs?
ATS Impact on Open Market Equity Trading 1
80%
70%
60%
50%
40%
30%
20%
10%
0%
2007
75% of
Equities
Traded on
Open
Markets
Figure 1.1 – ATS Impact on Open Market Equity Trading
1 Source: Aite Group Independent Research, 2007
2011
62% of
Equity
Traded on
Open
Markets
• Traditional exchanges have grown worried
• “Dark Pools” (ATSs) have funneled away business
• NASDAQ/NYSE have forged partnerships with foreign exchanges
• Also purchased smaller
ATS exchanges

Uses of Dark Pools of Liquidity
How are they used? What are their advantages? What are ATSs?
• Although studies don’t agree on the %age, they all agree “dark pools” are growing
• Domestically and Globally
Dark pools are steadily gaining market share in both the US and Europe
11
.5
% 12
.5
%
7.
5%
10% % Traded
Volume
(dark)
7%
5%
4%
3%
18
1.
5%
1%
3
2005
2%
27 4
2006
2%
32 9
2007
US
45 21
2008
Europe
52 29
2009
53 36
2010
No. of
Dark
Venues
Source: TABB Group Estimate

Potentials for Abuse
Do Dark Pools have potential for Abuse? Have they been abused?
• Lack of Transparency = Lack of Regulation
• Lack of Regulation = Abuse?
• Open markets work with the SEC
• Cooperation occurs to Investigate potential abuses/fraud
• SEC can fine…heavily
• SEC fined NYSE/Nasdaq $8.25 million…for failure to keep emails
• Gives SEC leverage with regards to regulating/implementing rules in open markets

Potentials for Abuse
Do Dark Pools have potential for Abuse? Have they been abused?
• In closed markets (ATS’s), there is little to almost no regulation
• Buyers & sellers essentially, regulate themselves
• Can we really trust large fund managers to regulate themselves?
• “Why regulate when were making money?”

Potentials for Abuse
Do Dark Pools have potential for Abuse? Have they been abused?
• Recent years financial modeling and computerized high volume fast paced trading have changed the marketplace
• In a closed exchange, this could lead to abuse
• Primarily, Pricing arbitrage
ar·bi·trage [ahr-bi-trahzh] –noun the simultaneous purchase and sale of the same securities, commodities, or foreign exchange in different markets to profit from unequal prices.

Regulations regarding Dark Pools
Are Dark Pools Regulated?
• Dark Pools lock out the “little guy”!
• People who don’t buy in large blocks
• Individual Traders
• Is that really fair?
• Regulation changes depending on country
• Asia
•
Dark pools put on open exchange
• Europe
•
MTF by UBS
• immediate post trade data available

Regulations regarding Dark Pools
Are Dark Pools Regulated?
• What about the United States?
• SEC is enacting new regulations to tackle unfairness which arises due to ATS use in 3 ways…
• Amending the definition of “bid or offer”
• Lowering the trading volume threshold that triggers the ATS order display
• Changing the existing jointindustry transaction reporting rules to require post-trade disclosure of the identity of the dark pool on which each trade is executed .
Mary
Schapiro
SEC Chair

Recommendations
How Should Dark Pools be regulated? What do we think?
• Ultimately what began as a “support” system for investors trying to unload large numbers of shares, has become something entirely different
• Essentially, we know have a two tier marketplace
• A market for low volume trading that is open and regulated
• Another market where large firms can trade huge amounts of shares with little to no regulation or oversight
• Dark pools can potentially be a systematic risk…
• Disclosure is essential in a global marketplace

Recommendations
How Should Dark Pools be regulated?