“Dark pools” that allow for trading of stocks outside of exchanges should be eliminated, Thain, 58, said in an interview with Erik Schatzker and Stephanie Ruhle on Bloomberg Television’s “Market Makers.” “The biggest problem is the fragmentation, you can trade stocks in 50 different places.”
Thain’s view echoes that of his successor, NYSE Euronext CEO Duncan Niederauer, who has decried the expansion of off-exchange equity trading. More than a third of all stock volume is now executed off exchanges, according to data compiled by Bloomberg.
The CIT chief said today that the markets owned by NYSE Euronext (NYX) and Nasdaq OMX Group Inc. (NDAQ), which own the listing venues for almost all U.S. stocks, should get to control when companies trade. Reg NMS, developed when Thain ran the NYSE, mandates shares must trade on whatever venue has the best price at any given time, which has helped markets proliferate.
“There’s no transparency in most of those places,” Thain said today. “That’s not good for the market, that’s not good for retail investors.”
Thain joined the NYSE in 2004 from New York-based Goldman Sachs Group Inc., which runs one of the biggest dark pools, Sigma X.
Niederauer and his counterparts at Nasdaq OMX Group Inc. and Bats Global Markets Inc. met in Washington in May and June with lawmakers and the U.S. Securities and Exchange Commission to discuss a rule that could divert more orders to exchanges rather than trading in dark pools or within a broker’s inventory.
Dark pools, which don’t publish bids or offers on shares, were set up to allow large investors to trade big blocks without having news of their orders move the price. NYSE and its peers contend that the original rationale no longer applies because, they say, the average trade size in dark pools has fallen to about 200 shares. As a result, the private venues are becoming less-regulated versions of traditional exchanges, they said.
SEC rules currently protect investors from receiving a worse price than the best available bid or offer. The exchanges want the SEC to pass a “trade-at” rule, which would require brokers to route an order to an exchange unless they can improve on the best public quote by a defined amount. Since Canada imposed such a rule last year, quoted spreads and volatility have fallen, the exchange’s CEOs told SEC Chairman Mary Jo White during a presentation May 1.
Brokers and operators of dark pools are trying to blunt the lobbying campaign, saying there’s no evidence that off-exchange trading hurts investors. Academic studies of fragmented markets have come up with varying results. Some found that dark trading is associated with wider bid-offer spreads on stocks and higher levels of volatility, while others have concluded it’s associated with lower transaction costs and better prices.
Officials from Morgan Stanley (MS) met in Washington May 22 with SEC commissioners and staff, as well as Wall Street’s self-regulator, the Financial Industry Regulatory Authority. They said a trade-at rule would reduce options for customers who want to prevent orders from leaking to the rest of the market.
Niederauer made the case for new rules in an April 29 letter to NYSE-listed companies, saying that off-exchange trading operates “with less regulatory oversight or accountability.”
Regulators approved a plan in July to require U.S. off-exchange markets such as dark pools to boost disclosure about the transactions they handle. The board of Finra, the private-sector overseer of U.S. brokerages, will propose rules to the government that would compel alternative trading systems to disclose the amount of volume they handle for each stock.
In addition to dark pools, other trading happens in private when brokers are paid to send their most profitable orders from retail investors to wholesalers, which handle the transactions within their own inventory. Brokers say the practice allows them to give retail investors slightly better share prices, as well as research reports and insurance against technology malfunctions and order errors.