Morgan Stanley Says SEC Dark Pool Proposal “Too Granular”
March 10, 2010
Morgan Stanley says in a comment letter to the Securities and Exchange Commission that its proposal to regulate dark pools is too “granular” and that instead a more fundamental approach is needed.
“Morgan Stanley believes that the real, underlying problem that needs to be addressed is the conduct of market participants,” write William P. Neuberger and Andrew Silverman, managing directors and global co-heads of Morgan Stanley Electronic Trading.
The SEC proposes to treat actionable indications of interest (IOIs), which strongly resemble quotes but are not included in publicly disseminated quote data, as quotes. The proposal would also reduce the Regulation ATS daily volume threshold in a specific security above which a dark pool must display its quotes from 5% to 0.25%, and it would require disclosing the identity of the venue on which trades occur in real-time.
Other comment letters on the Securities and Exchange Commission’s proposal, called “Regulation of Non-Public Trading Interests” and issued Nov. 13, also recommend the regulator should take a more holistic approach by including other pending issues such market centers’ flash orders and accessing market centers. But they tend to criticize the proposal’s provisions, rather than point to a more fundamental flaw.
Comments were due Feb. 22. Morgan submitted its comment March 4.
Morgan Stanleys says market economics are at the root of concerns about trading in dark pools.
Its letter notes that many of the issues the SEC is currently addressing are “symptoms” of aggressive order handling and routing practices that have emerged in recent years.
Those symptoms include (1) actionable indications of interest, which resemble quotes and (2) blind pinging of the market by some players who look for clues of larger orders to trade against.
“The economic incentives that exist in the market to reduce execution costs inevitably lead to a race for cheaper execution alternatives,” the authors say.
That’s prompted the roles of market participants such as exchanges and broker-dealers to overlap.
For example, Morgan Stanley says, many dark pools run by broker-dealers now openly compete with exchanges “and actually market themselves as execution venues.”
Meanwhile, the exchanges replicate traditional broker-dealer activity by “soliciting the other side of orders to their exchange books to minimize routing costs and increase their market share,” Morgan Stanley says.
The firm adds exchanges have become for-profit organizations while broker-dealers must balance best execution obligations to customers with routing to destinations that can save them millions of dollars in annual transaction costs.
Larry Tabb, founder and CEO of Westborough, MA-based Tabb Group, notes that exchanges now provide the order-routing services once dominating by broker-dealers, and in some cases they own broker-dealers to do the routing.
He also notes NYSE Euronext’s acquisition of Nyfix Millennium, enabling it to connect directly to buy-side clients. “More and more the exchanges are looking like broker-dealers and vice versa,” Tabb says.
As a result, “market participants are engaging in selective cost saving activities traditionally associated with other market participants’ roles without necessarily being subject to the same regulatory obligations,” says Morgan Stanley.
