Bloomberg News

Morgan Stanley Changing Dark Pool to Attract Bigger Orders

September 21, 2011

(Adds proportion of U.S. trading in seventh paragraph.)

Sept. 21 (Bloomberg) -- Morgan Stanley plans to alter the way it brings orders together in dark pools, trying to encourage bigger trades for institutional customers after a three-year decline in the number of shares per transaction industrywide.

The bank, which operates venues in the U.S., Europe, Hong Kong, Japan and Australia that match buyers and sellers without showing bids and offers, will give priority to larger orders at a specified price instead of those that arrived first, Bill Neuberger, co-head of Morgan Stanley Electronic Trading, said in a phone interview. MS POOL, which is adopting a model similar to one used by a Nasdaq OMX Group Inc. exchange, is among the first dark pools to offer the protocol in the U.S.

“We want to reward size and de-emphasize speed,” Neuberger said. MS POOL had the second-smallest average trade size in July among venues tracked by Rosenblatt Securities Inc. They averaged 209 shares in August, Neuberger said. “Fewer 100- share prints in dark pools may be a good thing,” he said.

Morgan Stanley’s changes are part of an effort to portray its venues as places where sophisticated users employing high- frequency strategies have less influence. Larger trade sizes may connote less interaction with proprietary trading firms, whose ability to sniff out and exploit the intentions of investors was one of the reasons dark pools gained popularity in the latter half of the last decade.

Getting Smaller

Trades in most dark pools average 200 shares to 300 shares, down from 300 shares to 400 shares in 2008 and 2009, Justin Schack, managing director for market structure analysis at Rosenblatt Securities, a New York-based broker that analyzes dark pool volume and trends, said in a phone interview. The decline may have resulted from more high-frequency penetration in venues that don’t display quotes, increased stock volatility, or algorithms reacting to trades they receive, he said.

U.S. dark pools followed by Rosenblatt accounted for 12.3 percent of U.S. volume in July, compared with 10.9 percent a year earlier. There are about 40 U.S. pools, with data from the largest included in Rosenblatt’s tally. A category of hidden orders on equity exchanges such as Nasdaq Stock Market and the New York Stock Exchange totaled 3.4 percent. More than 9 percent of volume on the main exchange run by Lenexa, Kansas-based Bats Global Markets was in dark or hidden orders, Rosenblatt said.

Market Share

MS POOL traded 61 million shares daily on average last month, or 0.6 percent of U.S. equity volume, according to data compiled by Morgan Stanley and Bloomberg. The broker had 0.7 percent of volume in July, Rosenblatt data showed. Credit Suisse Group AG’s Crossfinder, the largest dark pool, had 2.2 percent of U.S. volume, followed by New York-based Goldman Sachs Group Inc.’s Sigma X with 1.5 percent. Zurich-based Credit Suisse’s venue had the smallest average trade size in July, with 188 shares, according to Rosenblatt data.

U.S. stock exchanges match orders submitted to them against incoming buy and sell requests based on when they were received, a system called price-time priority. Among markets run by larger exchange operators, only the New York Stock Exchange and NYSE Amex allow certain firms -- brokers working on the exchange’s floor and so-called designated market makers -- to jump ahead and execute alongside those next in line to trade. Nasdaq OMX PSX, which relies on price-size priority, began last year.

Order Size

Existing orders at a given price in MS POOL will trade based on the number of shares they initially represented. If a firm wants to buy 1,000 shares and another subsequently bid for 5,000 shares, the second one would move ahead of the 1,000-share order. Even if smaller orders trade against the 5,000 shares and 500 shares remained, the order retains its priority because it initially was bigger, Neuberger said from New York.

Nasdaq OMX PSX has a different version of price-size priority. Existing orders trade based on the number of shares they represent, with incoming orders distributed proportionally. In the last example, an incoming order for 600 shares would trade 500 shares against the 5,000-share bid and 100 against the smaller one. Nasdaq OMX chose this method to avoid hurting the senders of smaller orders that are publicly displayed who might otherwise not send bids or offers.

Sapna Patel, head of market structure and liquidity strategy for the Americas for Morgan Stanley, said a customer in a dark pool isn’t revealing his intentions because bids and offers aren’t public. “Since it’s a different model,” the trader may opt to supply larger orders, she said.

The new rules are expected to become effective in MS POOL in the U.S. and Europe next week and in Asia later this year, she said.

Customer Curiosity

Investment Technology Group Inc.’s Posit dark pool uses price-size priority to match buy and sell orders, according to J.T. Farley, a spokesman. Other dark pools employ versions of the protocol. Bids Trading LP gives users a choice about how to execute their trade requests, Tim Mahoney, chief executive officer of the dark pool operator, wrote in an e-mail. Both companies are in New York.

Whit Conary, chief executive officer of Level ATS, a Boston-based dark pool operator, said investors have asked venues that don’t display quotes for more information about what kind of traders are on their system, what kind of orders are available and how rules on the platforms work. The information helps users make better decisions about where they want to send orders, he said. More brokers are also reporting trading volume to Rosenblatt to increase transparency in the market. Level traded almost 49 million shares in July, Rosenblatt data showed.

‘Electronic Way’

“More broker-dealers are finding it’s efficient to have an electronic way to match internal sources of order flow,” Conary said in a phone interview. The result is that more dark pools are finding customers, he said.

Morgan Stanley introduced MS POOL in the U.S. in 2006 and in Europe in 2008. It runs another network called MS Trajectory Cross in countries where MS POOL operates. That system matches pieces of bigger algorithmic orders according to the stock’s average price weighted by volume over a period of time.

Morgan Stanley hasn’t allowed some types of trading that other dark pools encourage to attract orders. The firm doesn’t let traders to submit orders that must be executed immediately or canceled. It doesn’t send messages called indications of interest to other pools or venues to solicit orders. Users must also keep orders in MS POOL for at least a second before withdrawing them -- a long time for many high-frequency traders. That discourages short-term players, Neuberger said.

Minimum-Share Requirements

Some customers are asking whether dark pools aggregate orders from users to get around minimum-share size requirements that some investors place on orders. Such a restriction might be sought to avoid trading against automated firms that prefer 100- share transactions.

Schack said he asked dark pools several months ago to count orders aggregated to meet a minimum-share size imposed by the counterparty as separate trades in their reporting. “Bulking” inflates the average trade size, which some investors use to assess the type of liquidity in a venue, he said.

Conary said Level, which is used by about 185 broker-dealer customers, lets members choose whether to allow minimum-share sizes they impose to be met by multiple orders.

Changes at MS POOL come as regulators in Canada and Europe are considering rules to limit trading in dark pools that don’t give investors better prices or larger executions than what’s publicly available. While the U.S. Securities and Exchange Commission has raised the prospect of a similar restriction, called a trade-at rule, many institutional investors and retail brokers have said they wouldn’t support that since it would hurt their transactions.

Trade Transparency

Separately, the SEC in October 2009 proposed rules that would increase transparency for trades in dark pools and reduce the amount of daily volume in a company’s shares that can be executed on the systems before prices must be made public. The agency hasn’t acted on that proposal, in part because of dozens of new rules it has had to write related to the Dodd-Frank Act, the financial overhaul enacted in July 2010.

“The SEC may be more likely to address the October 2009 proposal first,” Schack said. “The trade-at rule is incredibly controversial. It has many organized, vocal opponents and very few organized and vocal supporters.”

--Editors: Chris Nagi, Stephen Kleege

To contact the reporter on this story: Nina Mehta in New York at

To contact the editor responsible for this story: Nick Baker at

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