What is a “dark pool” anyway?
Last week we announced the expansion of the UBS Price Improvement Network (UBS PIN) to Australia, providing clients there with access to off-exchange, non-displayed – or “dark pool” – liquidity for the first time. It’s a kind of liquidity we’ve already made available in the US, Europe and, most recently, Hong Kong – but what exactly is a “dark pool” anyway?
Essentially, a dark pool is a network of order flow collected together in a single venue for the purpose of crossing orders against each other without a visible quote or order book. Crossing occurs when two orders execute against each other, without a public quotation, off the Exchange. By keeping their order non-displayed, or “dark”, the client has less chance of information leakage and/or market impact, a reaction to visibility that “moves the price” away from you. Though sometimes viewed as controversial because of its rather menacing connotation, “dark” became a popular term for this kind of liquidity since it quickly conveyed the idea that these orders were not visible.
For example, suppose you wanted to acquire a large position in Acme Anvil Company. You send a “buy” order for 100,000 shares. The moment your large order hits the market what will sellers of Acme do? They will raise the price before sending more sell orders to the exchange – and by the time your order fully executes, your price paid for Acme ends up being significantly higher.
If, instead, you sent that Acme order to a dark pool, your interest in Acme would not have been visible, so your order might have anonymously matched with Acme sell orders at a much lower price.
In markets such as these, saving a fraction of a basis point on your trades over the course of time can mean the difference of millions, or tens of millions of dollars, pounds or euros to large investment managers. The effect on performance can be significant – which in turn has a direct impact on the ability of an investment manager to retain client assets.
Dark pools can be independent structures, an “alternative trading system”, (ATS – the US regulatory structure) or a “multilateral trading facility” (MTF – the European regulatory structure), providing trading executions that occur outside of the local exchange. There are also internal crossing networks that are broker-owned facilities, such as our own UBS PIN or Goldman Sachs SIGMA, which are designed to cross client flow with internal orders.
No matter the structure, though, trading anonymity is what “dark liquidity” is all about. It also explains why dark pool liquidity has become such a key factor in today’s equities environment. By making dark liquidity available to our clients, UBS is assisting them in protecting their orders from market impact, and potentially improving their price performance – which is the cornerstone of best execution.
No matter the structure, though, trading anonymity is what “dark liquidity” is all about. It also explains why dark pool liquidity has become such a key factor in today’s equities environment. By making dark liquidity available to our clients, UBS is assisting them in protecting their orders from market impact, and potentially improving their price performance – which is the cornerstone of best execution.
