As more liquidity flows into dark pools, there is an increasing fear among participants that their trade information might be used by another party for financial gain.
This is known as “gaming” and both independent and broker-dealer-owned dark pools are serious about preventing it or catching the perpetrators.
Trading in a dark pool of liquidity is supposed to be safe-an institution should be able to place and execute a large order without moving the market or tipping off anyone who might want to profit from the information.
But with at least 10% of daily volume going through dark pools, according to consultancy Tabb Group, the temptation for gaming is growing.
Laurie Berke, an analyst with Tabb Group, says gaming is one of the things that most concerns the buy side. “It is an issue-the buy side is concerned about it, thinking about it and looking at it all the time.”
A buy-side equities report from Tabb last year revealed that 60% of the buy-side participants surveyed said fear of gaming had an impact on their decisions to interact with dark pools.
“Gaming is a real problem and various dark pools have different ways of dealing with it.” Says Rob McGrath, head of trading for the Americas at asset management firm Schroders.
“Gaming is one of the most important things our members talk about. Every institution thinks its order has the most value to everyone else so we have to protect the integrity of the pool. If you are accessing it but not trading that won’t do,” says Steven Greenblatt, head of sales at non-broker venue Liquidnet.
Liquidnet constantly monitors the system with technology tools and has a full-time member of staff to look for patterns of abuse and to notify relationship managers or members when a trader appears to be gaming. If so, they are barred from using the system. The venue has about 500 members and, over the course of its seven-year history, has suspended about 100 members.
Broker-dealers are not immune to gaming and Rishi Nangalia, managing director and head of business development for Goldman Sachs Electronic Trading, says: “Any dark pool should have anti-gaming measures. We have a team dedicated to ensuring that our execution quality remains safe.”
He says Goldman Sachs is also selective when it comes to allowing other firms to interact with its dark pool Sigma X.
Credit Suisse relies on algorithms to detect and stop gaming. “We are aware there is gaming going on and we have developed technology to mitigate against it. In our algorithms we have a fair pricing model that detects gaming and stops trading in the stock until it is over,” says Dmitri Galinov, a director for Advanced Execution Services at Credit Suisse.
Merrill Lynch does something similar. “On the electronic side, all our algorithms have built in anti-gaming logic to ensure that our clients’ orders are protected in the various dark pools that they access,” says Ruth Colagiuri, a director in the electronic trading group at Merrill Lynch.
The buy side may have just cause for concern about gaming but it is not stopping them from using dark pools. “It might be legitimate paranoia but it is not enough to make a trader avoid a pool,” Berke says.