Banks begin to dip into ‘dark pools’

Morgan Stanley is joining the growing list of banks that are challenging stock exchanges by forming “dark liquidity pools”, internal trading platforms that anonymously match buy and sell orders.

The dark pools, also known as dark books or internal crossing networks, pose a potential competitive threat to exchanges, by internally matching orders without publishing quotes – a service that is particularly popular with traders using computer-executed strategies.

Morgan Stanley’s new platform – called MS Pool – is the bank’s first branded offering in this area, although it was one of the first entrants to the dark pool market in the late 1990s. It joins about a dozen such entities, each with a slightly different approach. Others include Goldman Sachs’s Sigma X, Credit Suisse’s CrossFinder and UBS’s Price Improvement Network.

Bill Neuberger, head of electronic trading at Morgan Stanley, said, “Orders coming into the system will have the ability to interact with Morgan Stanley order flow before being routed externally to the exchanges.”

The creation of dark pools represents the latest challenge to the New York Stock Exchange and Nasdaq as the two largest US equities exchanges seek to expand internationally – the NYSE through a planned merger with pan-European exchange Euronext and the Nasdaq through its stake building in the London Stock Exchange.

“This is a threat to the exchange as the traditional hub of liquidity,” said Bill Cline, head of the capital markets practice at consultant Accenture. “These dark pools are an alternative mechanism to the traditional exchange, absent many of the fees and costs of an exchange.”

Mr Cline said: “The popularity of dark pools is a shot across the bows of the NYSE Group and Nasdaq duopoly, especially if fees increase.”

Catherine Kinney, NYSE president, told a recent Securities Industry Association conference that these systems were impairing price discovery. She said every share crossed “in the dark” was a share that did not assist the market in determining an accurate price.

The NYSE and Nasdaq might be hoping that regulators help them fend off these systems. Under Regulation National Market System, controversial proposals that attempt to level the playing field, any trading venue that accumulates more than 5 per cent of US equity volume must provide open quotes to the broad market.