Professor Unveiled New Research Showing Dark Pools Decreased Quality of Price Formation

The corporate regulator must not employ a one-size-fits-all approach to dark trading to ensure it stamps out harmful levels of activity in so-called "dark pools" without removing some of the benefits of trading away from exchanges, according to a leading consultant and professor.

As the market awaits the outcome of the Australian Securities & Investments Commission's taskforce into dark trading due this month, University of Melbourne professor Carole Comerton-Forde has unveiled new research showing dark pools decreased the quality of price formation in the stockmarket when above 10 per cent of total volume.

But Prof Comerton-Forde, who is consulting for ASIC on market structure issues, said some dark trading was beneficial for the market and so-called block trades are actually "enhancing the quality of the price discovery process".

"Some dark trading is good, but when we get beyond about 10 per cent . . . in non-block size we're starting to see some harm in the quality of price formation," she said in Sydney yesterday.

Dark trading is when orders are done without pre-trade transparency and has long existed in Australia, largely as block trades, or deals worth more than $1 million executed by brokers for institutional clients away from the exchange, to limit price impact and information leakage to the market. Dark trades are reported to the exchange on completion.

The proliferation of dark pools since 2009 has led to worries about the impact on pricing and liquidity on "lit" markets such as the ASX and Chi-X as more trades worth less than $1m move into dark pools. Since 2005, 18 crossing systems have been formed - largely by the brokers who pay lower fees to do client trades in their pools - and fund managers have raised concerns about how the pools operate in terms of client priority and if they allow high frequency traders.

The ASX, which also operates a dark pool, has lobbied for the brokers' pools to be regulated like regular stockmarkets, which Treasury has reviewed and is expected to shed light on soon.

Prof Comerton-Forde said while the overall level of dark trading remained stable in recent years it would be "more desirable" for fund managers if there was greater transparency around how orders are matched in brokers' crossing systems.

She added that new rules to come into effect in May, including for non-block dark trades, would reduce the level of dark activity as they are forced to offer a better price than what's being displayed in the lit market.

Stockbrokers Association of Australia chief executive David Horsfield said brokers had embraced dark pools in different ways and he expected more rules to come in, potentially in line with those by Canadian regulators.