The Australian independent academic researchers analysed Canadian dark trading before and after the introduction of minimum price improvement rules in October 2012 and found low levels of dark trading reduced transaction costs and improved market efficiency.
“The dark trading that we are looking at is from continuous dark pools. These transactions tend to be quite low. These are small orders; they are not large orders that are going through the dark pool,” Sean Foley, CMCRC research analyst and one of the report authors, told InvestorDaily.
The study looked at stocks that were continuously dark traded and found increases in the efficiency in the lit markets, as well as a reduction in illiquidity, a reduction in misquoted returns and a reduction in time delays.
“We exploited this natural experiment to examine the effects of continuous (non-block) dark trading on the market ...[and] rigorous testing of the data consistently showed that dark trading at the level observed in Canada is a positive force for market quality and efficiency,” Mr Foley stated.
CMCRC said the Canadian example suggests that there is a point where dark pools become harmful.
“We found that dark trading is beneficial in moderation … At the levels observed in Canada, which are below the indicative 10 per cent tipping point found using Australian data, dark pools have a valuable niche in financial markets,” Mr Foley said.
The results have implications for Australia, as the regulator has recently introduced similar rules regarding dark trading.
“We haven’t looked specifically at Australia, but this study’s results could be extrapolated to suggest the regulation could be positive for the local market if it prevents dark trading from increasing to a point where it becomes detrimental,” Mr Foley said.
CMCRC said future studies should examine the exact tipping point at which dark trading changes from beneficial to harmful.
“As more regulators look to implement rule changes around dark pools, there will be ample opportunity to study these effects ... It’s my hope that studies such as this will provide valuable evidence so that regulations can be made on an informed, rather than arbitrary basis,” Mr Foley said.
