Table Of ContentGlobal Financial Markets series
Global Financial Markets is a series of practical guides to the latest fi nancial market tools, techniques and
strategies. Written for practitioners across a range of disciplines it provides comprehensive but practical
coverage of key topics in fi nance covering strategy, markets, fi nancial products, tools and techniques and
their implementation. Th is series will appeal to a broad readership, from new entrants to experienced
practitioners across the fi nancial services industry, including areas such as institutional investment;
fi nancial derivatives; investment strategy; private banking; risk management; corporate fi nance and
M&A, fi nancial accounting and governance, and many more.
Titles include:
Erik Banks
DARK POOLS, 2nd Edition
Off -Exchange Liquidity in an Era of High Frequency, Program, and Algorithmic Trading
Erik Banks
LIQUIDITY RISK, 2nd Edition
Managing Funding and Asset Risk
Daniel Capocci
THE COMPLETE GUIDE TO HEDGE FUNDS AND HEDGE FUND STRATEGIES
Sandy Chen
INTEGRATED BANK ANALYSIS AND VALUATION
A Practical Guide to the ROIC Methodology
Frances Cowell
RISK-BASED INVESTMENT MANAGEMENT IN PRACTICE, 2nd Edition
Jawwad Farid
MODELS AT WORK
A Practitioner’s Guide to Risk Management
Guy Fraser-Sampson
INTELLIGENT INVESTING
A Guide to the Practical and Behavioural Aspects of Investment Strategy
Michael Hünseler
CREDIT PORTFOLIO MANAGEMENT
A Practitioner’s Guide to the Active Management of Credit Risks
Felix Lessambo
THE INTERNATIONAL CORPORATE GOVERNANCE SYSTEM
Audit Roles and Board Oversight
Ross K. McGill
US WITHHOLDING TAX
Practical Implications of QI and FATCA
David Murphy
OTC DERIVATIVES, BILATERAL TRADING AND CENTRAL CLEARING
An Introduction to Regulatory Policy, Trading Impact and Systemic Risk
Gianluca Oricchio
PRIVATE COMPANY VALUATION
How Credit Risk Reshaped Equity Markets and Corporate Finance Valuation Tools
Andrew Sutherland and Jason Court
THE FRONT OFFICE MANUAL
Th e Defi nitive Guide to Trading, Structuring and Sales
Michael C. S. Wong and Wilson F. C. Chan ( editors)
INVESTING IN ASIAN OFFSHORE CURRENCY MARKETS
Th e Shift from Dollars to Renminbi
Global Financial Markets series
Series Standing Order ISBN: 978–1137–32734–5
You can receive future titles in this series as they are published by placing a standing order. Please contact your bookseller
or, in case of diffi culty, write to us at the address below with your name and address, the title of the series and the ISBN
quoted above.
C ustomer Services Department, Macmillan Distribution Ltd, Houndmills, Basingstoke, Hampshire RG21 6XS, England
Also by Erik Banks:
LIQUIDITY RISK, 2nd Edition
RISK CULTURE
SEE NO EVIL: UNCOVERING THE TRUTH BEHIND THE FINANCIAL CRISIS
FINANCE : THE BASICS, SECOND EDITION
DICTIONARY OF FINANCE, INVESTMENT AND BANKING
RISK AND FINANCIAL CATASTROPHE
SYNTHETIC AND STRUCTURED ASSETS
CATASTROPHIC RISK
LIQUIDITY RISK
THE FINANCIAL LEXICON
THE FAILURE OF WALL STREET
ALTERNATIVE RISK TRANSFER
WORKING THE STREET
CREDIT RISK OF COMPLEX DERIVATIVES, 3rd Edition
CORPORATE GOVERNANCE
EXCHANGE-TRADED DERIVATIVES
THE SIMPLE RULES OF RISK
E-FINANCE
THE RISE AND FALL OF THE MERCHANT BANKS
ASIA PACIFIC DERIVATIVE MARKETS
EMERGING ASIAN FIXED INCOME MARKETS
CREDIT RISK OF FINANCIAL INSTRUMENTS
OPTIONS APPLICATIONS (C o-authored with P. Siegel )
CREDIT DERIVATIVES ( Co-authored with M. Glantz and P. Siegel )
PRACTICAL RISK MANAGEMENT (C o-authored with R. Dunn )
WEATHER RISK MANAGEMENT ( Edited and co-authored with XL Financial )
Dark Pools
Off -Exchange Liquidity in an Era of High
Frequency, Program, and Algorithmic Trading
2nd edition
Erik Banks
© Erik Banks 2010, 2014
Softcover reprint of the hardcover 2nd edition 2014 978-1-137-44953-5
All rights reserved. No reproduction, copy or transmission of this
publication may be made without written permission.
No portion of this publication may be reproduced, copied or transmitted
save with written permission or in accordance with the provisions of the
Copyright, Designs and Patents Act 1988, or under the terms of any licence
permitting limited copying issued by the Copyright Licensing Agency,
Saffron House, 6–10 Kirby Street, London EC1N 8TS.
Any person who does any unauthorized act in relation to this publication
may be liable to criminal prosecution and civil claims for damages.
The author has asserted his right to be identifi ed as the author of this work
in accordance with the Copyright, Designs and Patents Act 1988.
First published 2014 by
PALGRAVE MACMILLAN
Palgrave Macmillan in the UK is an imprint of Macmillan Publishers Limited,
registered in England, company number 785998, of Houndmills, Basingstoke,
Hampshire RG21 6XS.
Palgrave Macmillan in the US is a division of St Martin’s Press LLC,
175 Fifth Avenue, New York, NY 10010.
Palgrave Macmillan is the global academic imprint of the above companies
and has companies and representatives throughout the world.
Palgrave® and Macmillan® are registered trademarks in the United States,
the United Kingdom, Europe and other countries
ISBN 978-1-349-49682-2 ISBN 978-1-137-44957-3 (eBook)
DOI 10.1057/9781137449573
This book is printed on paper suitable for recycling and made from fully
managed and sustained forest sources. Logging, pulping and manufacturing
processes are expected to conform to the environmental regulations of the
country of origin.
A catalogue record for this book is available from the British Library.
Library of Congress Cataloging-in-Publication Data
Banks, Erik.
Dark pools: off-exchange liquidity in an era of high frequency, program and
algorithmic trading / Erik Banks.
pages cm.—(Global fi nancial markets)
“Second edition” – Preface.
Revised edition of the author’s Dark pools: the structure and future of
off-exchange trading and liquidity, published in 2010.
Includes bibliographical references and index.
1. Capital market. 2. Liquidity (Economics) 3. Risk. I. Title.
HG4523.B364 2014
332.6492—dc23 2014024789
Contents
List of Illustrations .............................................. vi
“Pools in Practice” Vignettes ....................................... viii
Preface to the Second Edition ...................................... ix
About the Author ............................................... xi
PART I MARKET STRUCTURE
1 Introduction to Dark Pools .................................... 3
2 Market Liquidity and Structure ................................. 33
3 Dark Pool Structure .......................................... 64
PART II MICRO ISSUES
4 Topics in Pricing and Execution ................................ 103
5 Trading in Dark Pools ........................................ 127
6 Aspects of Technology and Architecture .......................... 153
PART III ENVIRONMENT OF THE FUTURE
7 Regulation, Control, and Transparency ........................... 177
8 Th e Future of Dark Pools ...................................... 204
Appendix 1 Listing of Dark Pool Sites ............................... 2 21
App endix 2 Listing of MiFID Regulated Markets, Systematic Internalizers,
and Multilateral Trading Facilities ............................... 223
Notes ........................................................ 2 30
Glossary ...................................................... 2 39
Selected Bibliography ............................................ 2 55
Index ........................................................ 2 59
v
Illustrations
FIGURES
1.1 Orders coming into various price points ....................... 15
1.2 Sources of dark liquidity ................................... 19
2.1 Twilight pools in the lit/dark market .......................... 38
2.2 Limit bids and off ers ...................................... 42
2.3 Reserve order execution in Stock XYZ ......................... 49
2.4 H idden order execution in Stock XYZ ......................... 50
2.5 Order types ............................................. 52
2.6 M arket structures ......................................... 59
2.7 Liquidity spectrum ....................................... 63
3.1 Types of alternative trading systems/multilateral trading facilities .... 71
3.2 Key types of crossing networks .............................. 80
3.3 Broker/dealer desk model .................................. 82
3.4 Examples of dark pool venues and mechanisms ................. 93
4.1(a) Limit order book: Stock XYZ ................................ 109
4.1(b) Limit order book: Stock ABC ................................ 109
4.2 Supply, demand, and market clearing price ..................... 111
4.3 C rossing at best bid off er ................................... 114
4.4 O rder entry into a crossing network .......................... 118
5.1 Implementation shortfall routine ............................. 144
5.2 Data feeds in HFT/ULLT ventures ............................ 149
6.1 Trade lifecycle ........................................... 159
6.2 R outing process .......................................... 163
6.3 Th e matching fl ow ........................................ 168
TABLES
2.1 Major classes of orders and primary motivations ................. 53
2.2 S tock EFG order book example 1 ............................. 53
2.3 S tock EFG order book example 2 ............................. 54
2.4 Stock EFG order book example 1, without illustrating the dark trade .. 54
3.1 Major global exchanges with hidden/reserve orders ............... 67
4.1 Stock ABC order book, pre-call ............................. 1 11
vi
Illustrations vii
4.2 Stock ABC order matching ................................ 111
4 .3 S tock ABC order book, post-call ............................ 112
4.4 Stock ABC, continuous-order market ........................ 113
6.1 Share blocks on various dark pools .......................... 165
6.2 Order fi ll against various dark pools ......................... 1 65
6.3(a) FOK buy limit order at $50.00, 1000 shares .................... 172
6.3(b) Dark sell peg order at the midpoint of the NBBO,
2000 shares and minimum quantity 1000 shares, valid market
open tomorrow (T + 1) ................................... 173
“Pools in Practice” Vignettes
A typical dark trade (Chapter 1)
Traderspeak ... (Chapter 2)
Twilight pools (Chapter 2)
Th e midpoint match (Chapter 2)
Th e slow death of fl ash trading? (Chapter 2)
Th e rise of the conditional order (Chapter 2)
Dark aggregation (Chapter 3)
Diff erent degrees of direct market access (Chapter 3)
Dipping into a toxic pool (Chapter 3)
Bond trading in the dark (Chapter 3)
Creating a synthetic NBBO (Chapter 4)
Th e robustness of the best bid-off er (Chapter 4)
Touch price crossing (Chapter 4)
Measuring dark market variables (Chapter 4)
Cash neutrality (Chapter 5)
Real life algo orders ... (Chapter 5)
Looking in the dark with algos (Chapter 5)
Ultra-low latency trading (Chapter 5)
Th e Flash Crash (Chapter 7)
Not every pool makes it ... (Chapter 8)
viii
Preface to the Second Edition
Th e marketplace for securities trading has continued evolving and growing since the
fi rst edition of Dark Pools was published in 2010. Specifi cally, following the devastat-
ing market crisis of 2007–2009, which sidelined many participants, an accelerating
market recovery began to appear in 2011 and 2012, bringing retail and institutional
investors back to the developed and emerging equity and fi xed income markets.
Th eir return has heralded growth in volume and liquidity, essential ingredients for
dark market expansion. In addition, new technologies have been introduced in the
programming, hardware, and networking sectors which have led to a new genera-
tion of increasingly sophisticated, and rapidly executed, trading strategies – includ-
ing high frequency/low latency trading and algorithmic trading. Furthermore, a
growing focus on cost reduction and profi t maximization has caused the largest
investors to fi nd ways of employing cost-saving solutions, like low market impact
trading and direct market access. Th ese forces, combined with consolidation and
restructuring in the exchange and off -exchange sector and a redraft ing of market
regulations, have led to a reshaping of the dark pool sector.
A gainst this background, dark trading remains an important fi nancial market
growth sector. By all available statistics – which are still challenging to derive in
a market that, by defi nition, remains opaque – dark trading now accounts for
approximately 40% of all U.S. turnover; the European share ranges from 8 to 15%
at any point in time, while countries such as Canada and Australia have breached
the 10% mark. Collectively, these are signifi cant market shares which have helped
solidify the function and legitimacy of the dark market.
Given the changes and growth in this important segment of the fi nancial markets,
it seems timely and appropriate to bring the original material in Dark Pools up to
date and to further expand its scope. Th e new edition refl ects current ideas on micro
and macrostructure and regulations.
More specifi cally, this new edition incorporates the following features:
• U pdates and new examples throughout the book to refl ect growth and change in
national markets and asset classes.
• Expanded sections on algorithms, high frequency and low latency trading,
aggregators, and market structures and their interaction with dark liquidity.
• Enhancements and updates on regulatory matters, focusing on eff orts in the
U.S. (via the SEC and FINRA), Europe (via MiFID II and MiFIR), Canada, and
Australia.
• N ew “Pools in Practice” vignettes which give a practical treatment of some of the
topics traders, exchanges, and other market participants are dealing with.
ix
