Professor Frino warns of 'dark pool' trading
07 Jun 2012
Professor Alex Frino, CEO of Capital Markets Co-operative Research Centre (CMCRC) and Professor of Finance at the University of Sydney Business School, today released new research indicating that trading conducted outside of the established stock exchanges in so-called 'dark pools' could damage market quality and increase trading costs in smaller stock markets such as Australia.
Frino unveiled his new research during a presentation in the Distinguished Speaker Series at the Australian Embassy in Washington DC.
Professor Frino has designed a mathematical model that demonstrates the impact on 'lit' stock markets when trading moves onto dark pools. According to Frino's model, if 20% of trading moves into the dark, it will increase trading costs on the established or lit exchange by almost 1 basis point. This is many times greater than the round trip exchange fee of 0.3 basis points.
"When trading moves off-exchange, trading costs on the lit exchange rise because markets fragment and this makes it more costly for buyers and sellers to find it each other" said Professor Frino. "This implies that dark trading has a significant negative impact on liquidity."
Professor Frino pointed out that his research was particularly acute in smaller markets such as Australia and Singapore. "We're seeing markets fragment in Asia as we did years ago in the US and Europe," he said. "The issue is that some Asian markets aren't big enough to handle it. Pulling liquidity off the lit exchanges, and the subsequent increase in trading costs, only further injures already struggling liquidity."
Frino also pointed out that there are different types of dark pools - 'internalisers', where investment banks trade against their client orders without ever exposing them to outside traders; and independent dark pools, which are essentially open to anyone.
"The debate about different types of dark liquidity is yet to begin," he said. "But it's one that regulators - and indeed investors - should be very interested in. It will effect superannuation fund returns in future."
Australia's Ambassador to the US, Kim Beazley, launched the Speakers Series in 2011. Mr Beazley described this year's speakers as "Australia's great thinkers, able to speak on issues of interest and importance both in the United States and Australia, such as the environment, science, health, culture and power relations in the Asia-Pacific region.
"My Speaker Series is designed to continue the frank, full and fearless discussion I and my embassy colleagues enjoy with representatives from the US Administration, Congress, universities, think tanks, industry organisations and the general public," Mr Beazley said.
Professor Frino has also given a presentation on "Challenges in the Asia-Pacific for Global Equity Markets" in Chicago and met with the Chicago Mutual Exchange.
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