P4Capital investigates Dark Pools and why some are washing out.

P4Capital is beginning a series of Podcasts and interviews featuring our executive team, who will be discussing pressing concerns for the Canadian financial industry.

This week’s topic, Dark Pools and why some are washing out.

 

Transcript

Amanda: Hello everyone, and welcome to another edition of the P4Capital round table discussions. I’m your host Amanda, and I am sitting here with our executive team: Jim, Shaheerah, Archana and Jeremy. This week’s discussion is about Dark Pools, more specifically the end of the Wells Fargo Dark Pool. Stay tuned and enjoy.

Jim: My name is Jim Carlson, I’m a partner in the firm and have been interested in working the Capital  Markets scene for the last 30 years

Archana: Hi, my name is Archana Ravinder. I’m an Account Manager with P4Capital.

Jeremy: Hi Jeremy Paczuski here, Client Executive with P4Capital

Shaheerah: My name is Shaheerah Kayani, I’m an Associate Recruiter with P4Capital.

Jim: Today’s topic is why did Wells Fargo close its Dark Pool.

Archana: Let’s start with the definition of a Dark Pool, what are Dark Pools? Dark pools are essentially electronic broker-run trading venues and essentially every big bank has one. But Wells Fargo essentially cited one of the reasons for why they closed down their Dark Pool is there has been a decrease in customer demand. And going by the stats in fact Wells Fargo’s Dark Pool, it was near the bottom of the 41 alternative trading systems that are out there in the market.

Shaheerah: So as Archana said, a Dark Pool or a Black Pool, is a private form for trading securities that is not openly available to the public. So liquidity on these markets is called Dark Pool Liquidity. Now Dark Pools allow investors to trade shares anonymously, and only make trading data available after a trade happens. So this is useful to traders, because by not revealing the information before hand they can prevent others in the market from figuring out what their trade intentions are. And so people won’t be able to move the price against them. When the details from these trades are hidden from the public, it’s as if you’re clouding transactions like murky water, and so hence the term Dark Pools.

Jeremy: At the risk of over simplifying here, I would further define Dark Pools simply as a private stock exchange run by a bank with little regulatory oversight.

Jim: Today’s topic is why did Wells Fargo actually close the Dark Pool. I think the statistic that just bounces right off the table is they were the bottom. So therefore they were not achieving liquidity, they therefore although don’t have to comply in terms of regulation as overt, they still have to comply, and there are costs involved in complying with regulation regardless if you’re in the open market exchanges, or your in the financial institution’s Dark Pools. Probably this is just a mere, or complete reflection of, for the money being spent they weren’t getting the return on what they were looking for. With that said, it now kind of begs the questions that come out, if they were bottom, they no longer are because they are closing their Darkpool down, whose next to close? And therefore, the story as it carries on, is who will be left? And, one of the things we always explore at p4Capital is technology an inhibitor, or is it something that detracts from some sort of business in the capital markets?

Jeremy: I think in this case Jim, technology is what enabled Dark Pools to exist in the first place. But they’ve kind of become a victim of their own success now. It’s pulled a complete 180 that technology is actually what’s hurting Dark Pools right now. They’re very vulnerable to predatory trading practices by high frequency traders, and potential conflicts of interest in the bank’s clients as well. One example of this is Barclays being sued in New York by the attorney general for securities fraud.

Shaheerah: Dark Pools have been subjected to a lack of transparency, and a lot of increased regulations, but still Wells Fargo says that its move was only due to falling demand and nothing to do with regulations. And meanwhile some traders who use Dark Pools argue that it should be publicized in order to make trading more fair for everyone.

Archana: Dark Pools is being, definitely a profitable business, something that case in point would be the number of Dark Pools that have sprouted up since the 2008 meltdown. Obviously Dark Pools offer distinct advantages when institutional investors are looking to move blocks of shares without the market essentially reacting to these trades.

Jim: As our round table looks at, our topics of the moment, and the real kind of discussion I’m kind of stating out-loud, is the money being spent on sophisticated algorithm programs, the amount of time spent on ensuring fibre optics to first to the market news, is that in fact being used right now to overcome any advantages that the Dark Pools maybe brought onto the marketplace in the 2008 to 2011 time-frame. So I could argue yes, or I could just argue that it’s a badly run business by Wells Fargo. Anyone else have an opinion on this?

Archana: Yes, in fact just adding to what Jim just said there, Wells Fargo’s Dark Pool, like I mentioned before was near the bottom of the 41 other sort of alternative trading systems that are out there. In terms of the number of shares that were traded that was less than seven million. In comparison Credit Suisse’s Crossfinder and other alternative trading system by the name of Liquidnet, actually saw almost 350 million shares executed during the same time-frame.

Jeremy: I think if you look at the history of stock exchanges over the last couple hundred years, you had the big board in New York, which was the dominant player, I’m not really sure when the Nasdaq came around but now we’re at the point where there’s 50, 60, 70, 80 who knows how many places where you can exchange stocks. Perhaps we’re past the critical mass where it really adds value, how many places do you really need to be able to buy and sell stocks? It has to be a finite number, maybe we’re there.

Jim: Which then begs the question on lines of business in the financial institutions which are being severely challenged by both common competitors and non-common competitors in 2014. 2015 looks like it will even enrich that, is can you run a line of business as a financial institution the way it was always done?  You know, passed down from generation to generation and I believe the speed of technology suggests you cannot. And unless you have combined practices of strategic digital marketing, along with aligned business objectives, is that you’re not doomed for success as opposed to doomed for failure just because you put up a sign and say hey, I’m in business and I think Wells Fargo found that out.

Archana: As my colleges have sort of pointed out to the fact that businesses, yes they need to adapt to the changes that are happening in the marketplace, Dark Pools for some of the banks they’ve worked out as a great strategy for some they haven’t, as the case in point would be Wells Fargo. But having said that the industry is also quite aggressively looking to bring about certain changes into the way these high-speed electronic trades really happen. So more regulatory policing so that fraud activities are caught in time. And yeah, Dark Pools essentially remain a profitable business. There is in fact a group in Europe which is sort of advocating some changes to the way trades are conducted, and some of the measures that they’re sort of advocating would be a minimum order size which might act as a barrier for some high-speed trading algorithms.

Jim: Dark Pools are just, as Jeremy said, they’re revolutionary up the food chain from the stock exchanges that started obviously in the London exchanges in the European Borses as it came over to North America. Now it’s all global. Big players are on the market, we’ve discussed that in past discussions. My real question is whose going to get into real-time exchanges, because back in the 80s when I was at GE we looked at a Global Electronic Exchange. The time wasn’t then, but the time may be upon us right now. So will one of the big volume handlers as Jeremy mentioned, will they take the next step? Will they invest in the appropriate technology that allows realtime trading on a seven by 24 by 365 basis? And if so, how much of the market share will they capture? I really think that, as opposed to watching minnows like Wells Fargo fall off the table, I think the real question may be who are the giants and who are ready to invest heavily in to technology to take the ultimate step which is the global electronic exchange.

Amanda: That was the P4Capital executive team talking about the end of the Wells Fargo Dark Pool. P4Capital, helping you and your company reach digital velocity quickly. Want to know more, check out our website at http://www.planet4it.com Thanks and see you next time. 


 

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