DARK POOLS OF LIQUIDITY

DARK POOLS OF LIQUIDITY 

Understanding & Technology dependencies for the future 

This whitepaper throws light over dark pools trading & the 

benfits of dark pool trading for institutional investors 

mainly. It also focusses on variuos types of dark pools in 

the market today and how the trading process is different 

as compared to the traditional exchange trading. 

Institutions Point-of-view: 

This paper also aims at coming up with the 

investors point of view on technology applicable and what 

could revolutonalize this trading mechanism in the future 

with more and more institutions like mutual funds, 

pension funds, hedge funds turning to this mechanism for 

liquidity 

Technology firms Point-of-view: This paper also throws light on what could be several 

technology companies’ startegies towards this growing market and how they can allign their 

offerings to these customers and improve business revenues and their shareholder value. 

Overall, this paper is targetted at an audience who is looking to gain an insight into the dark 

pools of liquidity and looking to understand the mechanism of dark pools trading, advantages 

and how technology would impact the operations or provide benefits in trading over this 

medium. Also provides the authors view point on the future of dark pools of liquidity, their 

existance and how oversight needs to change to be able to create a competitive market space. 

Understanding & Technology dependencies for the future 

RAVIKIRAN ACHUTHAKUMAR 

Business Analyst, Wipro Technologies

Table of Contents 

Dark pools of liquidity 2009 

DEFINITIONS & INTRODUCTION ................................................................................................................................ 3 

WHY ARE THEY REQUIRED? ..................................................................................................................................... 4 

TYPES OF LIQUID POOLS .......................................................................................................................................... 5 

EXCHANGE TRADING (VS) DARK POOL TRADING ....................................................................................................... 6 

HOW DO THEY IMPACT THE CURRENT MARKET? ....................................................................................................... 9 

FRAGMENTED MARKETS PERSPECTIVE TO DARK POOLS ............................................................................................. 9 

TECHNOLOGIES THAT CATER TO THIS INDUSTRY NEEDS ........................................................................................... 11 

SOFTWARE VENDORS CAN HAVE SOLUTIONS & OFFERINGS ...................................................................................... 11 

KEY RISK MANAGEMENT INITIATIVES IN THE DARK POOL ARENA ............................................................................. 11 

CONCLUSION & WAY FORWARD >> ........................................................................................................................ 12 

Page2

Definitions & Introduction 


“Dark Pools of Liquidity“ a slang term that refers to the trading volume 

created from institutional orders, which are unavailable to the public. Also referred 

to as the "upstairs market" which allows buyers and sellers to specify block trades 

facilitated away from the central exchanges. 

When a trade in a listed stock is not executed through the listing exchange, rather done over a 

computerized financial trading methods that use peer to peer networks (crossing networks instead of 

traditional central clearing hubs) to hide trades. This gives an advantage to those trading and a 

disadvantage to those outside of the trade. 

The dark pool gets its name because details of these trades are concealed from the public, clouding the 

transactions like murky water. Dark pools of liquidity (also dark pools or dark liquidity) are crossing 

networks that provide liquidity that is not displayed on order books. This is useful for traders who wish to 

move large numbers of shares without revealing themselves to the open market 

Agenda 

for Paper 

Dark pools are similar to what the NYSE was before it became an 

automated market. 

Recently, more than 20% of all trades in New York Stock Exchangelisted 

stocks have been funneled through these dark pools, up from 

just 3% to 5% two years ago, according to NYSE figures. 

"Exchanges are beginning to look a lot more like ATS's (alternative 

trading systems, or dark pools), while ATS's are looking more like 

exchanges." 

This whitepaper throws light over dark pools trading & the benfits of dark pool 

trading for institutional investors mainly. It also focusses on variuos types of 

dark pools in the market today and how the trading process is different as 

compared to the traditional exchange trading. 

Institutions Point-of-view :This paper also aims at coming up with the 

investors point of view on technology applicable and what could revolutonalize 

this trading mechanism in the future with more and more institutions like mutual 

funds, pension funds, hedge funds turning to this mechanism for liquidity 

options. 

Technology firms Point-of-view: This paper also throws light on what could be several technology 

companies’ startegies towards this growing market and how they can allign their offerings to these 

customers and improve business revenues and their shareholder value. 

Overall, this paper is targetted at an audience who is looking to gain an insight into the dark pools of 

liquidity and looking to understand the mechanism of dark pools trading, advantages and how technology 

would impact the operations or provide benefits in trading over this medium. Also provides the authors 

view point on the future of dark pools of liquidity, their existance and how oversight needs to change to be 

able to create a competitive market space. 

Page3

Why are they required? 


Liquidity in standard financial markets is often openly advertised in order to attract additional liquidity 

to that venue and is usually done in real time by publishing market depth. 

Darl pools of liquidity arises from traders’ concern that if they clearly indicate their intention to buy 

large amount of a particular stock, they will drive the price of that stock up ahead of their trade, therby 

not be able to take up a competitive position in the market. 

The standard structure of a market place is as shown below with various participants 

Dark pools of liquidity has been around for a long time in the form of orders represented by floor brokers 

on the trading floors of the NYSE and the other exchanges 

Some of the main reasons for dark pools trading are as listed below; 

1. Trades can be processed anonymously, without impacting the price 

2. Dark liquidity is generally used to try and reduce market impact when trading large orders 

3. Dark liquid pools are becoming the execution destination of choice for increase number of buyers 

and sellers because of their increased liquidity nowadays and also able to provide lower 

transaction costs while providing anonymity of the trader. 

4. Dark pools of liquidity have existed for some time, but it is now that technology has made it easier 

to access them - the value of accessing as much liquidity as possible has been understood. 

5. Dark pools offer flexibility to customers and are particularly popular with brokers who use 

computer-executed strategies 

6. More recently, dark pools also make it easier to trade small- or mid-cap stocks, which are often 

lower-profile companies that, because they're less liquid, are harder to trade publicly. 

Fragmentation in the market has formed a lot of ‘dark pools’ of liquidity, which can only be accessible 

through electronic means and Algo trading is making the most of them possible. 

Page4

Types of Liquid Pools 


Over the years the dark pools have evolved based on localization with respect to different brokerage 

houses and other investor’s likings. Several institutions developed propreitery platforms in order to enable 

trade trough this methodology and seek the desired benefits of trading large orders with anonmity. 

Dark pools can be classified on 4 types - that are competing in the market as of today; 

Highlights: (figure 1) 

• Independent platforms 

• Broker-dealer internal matching engines 

• Consortium-led pools, and 

• Exchange-crossing networks 

Instinet 

Popular Independent dark pools 

Investment Technology Group (ITG) 

Liquidnet 

NYFIX Millennium 

Pipeline Trading Systems 

Pulse Trading 

Firms engaged in dark liquid pools 

BNY ConvergEx Group (an affiliate of Bank of New 

York Mellon) 

Citi Markets and Banking 

Credit Suisse 

Fidelity Capital Markets Services 

Goldman Sachs Execution and Clearing 

Knight Capital Group 

Lehman Brothers 

Merrill Lynch 

Morgan Stanley 

UBS Investment Bank 

Fig 1 

Exchange-owned dark pools 

International Securities Exchange 

The NASDAQ Stock Market 

NYSE Euronext 

Direct Edge 

Consortium-owned dark pools 

BIDS Trading 

eBX LLC 

Exchange-owned dark pools 

International Securities Exchange 

The NASDAQ Stock Market 

NYSE Euronext 

Direct Edge 

Chi-X 

Mismi 

Other dark pools 

Page5

Exchange trading (vs) Dark pool trading 


Let’ s us quickly understand the normal trading process that takes place in an ideal market scenario in 

order to see the difference and benefits that the dark pool trading offers to large investors. 

Trading over the exchange: 

The figure below depicts the normal trading process and different points of handshake between 

middlemen & institutions that make a trade possible and help investors in their transactions of securities/ 

scrips 

Trader 

Illustration Scenario: 

Process Flow of orders – Normal Scenario 

Displayed Order 

Depository 

Systems 

BUY 

ORDER 

Algorithms 

Platforms 

ECN / ATS / EB 

Regulator 

Clearing House 

Custodians 

Registrar 

SELL 

ORDER 

Algorithms 

Platforms 

Displayed Order 

Others 

Cash 

Accounting 

Client 

Clearing Bank 

Systems 

ECN – Electronic Communication Networks 

ATS – Alternative trading systems 

EB – Executing brokers 

In an ideal scenario, when a trader would like to either buy/sell shares over the exchange, there are a 

series of interaction with various parties involved in the completion of the trade between the 2 parties. 

Below are a few steps that are essential to every trade transaction that happens over the exchange. 

1. The trader who would like to buy/sell the security would call his broker and place an order to 

buy/sell the securities at a willing /expected price. 

2. The authorized broker would then place the order over the exchange through the electronic 

systems. 

3. Once the order gets accepted, a contract note / electronic confirmation provided to the trader. 

4. Trade details from the exchange is then passed to the clearing house 

Page6


5. The clearing members provide the information to custodians; based on the acknowledgement 

they identify the obligations. 

6. Instructions for clearing banks / depositiries to submit the funds/securities – pay in 

7. Pay out of funds and funds to appropriate parties takes place 

8. Depositories and clearing banks provide information to their respective parties. 

The above cycle of activites happen for each and every trade over the regular market scenario. 

Trading Over Dark pools 

Now, let’s quickly understand the process of trading over dark pools. Once we see the trading cycle we 

shall be able to compare the 2 trading processes and be able to understand the difference and benefits 

derived by large volume traders. The below diagram indicates the trading cycle over dark pools. 

Trader 

Others 

Non-Disclosed Order 

Cash 

Accountin 

g 

Illustration Scenario: 

Crossing Networks 

Depository 

Systems 

Clearing Bank 

Systems 

Trading Over Dark Pools 

BUY 

ORDER 

Dark pool of Liquidity 

•Independent Platforms 

•Broker Dealer platforms 

•Consortium led pools 

•Exchange crossing 

networks 

Brokerage House 

Custodians 

Registrar 

SELL 

ORDER 

Non-Disclosed Order 

Crossing Networks 

Benefits Derived Through Dark 

Pool Trading 

More Anonymity & Rapid Exec 

Reduced Transaction cost 

Reduced Market Impact 

More Liquidity than public 

markets 

• The trader who would like to buy/sell the security would call his broker or place an order over the 

electronic system of the broker to buy/sell the securities at a willing /expected price. 

• The broker then interalizes the order and looks for suitable matches within his network - by 

breaking the orders into smaller pieces, computer programs match and execute the different 

segments of the order in hundreds of separate transactions 

• The transaction details are then informed to the other parties concerned – depository and 

custodians for the clearing and settlement to take place. 

• The confirmation of the trade and trade details are then provided to the 2 parties. 

Therefore, Dark pools, by contrast, do not alert the market makers that a sizeable order has been placed. 

In the process, information about the trader / institution's intent to sell would not leak out to other traders. 

Therefore, the shares would not be under pressure, and the seller would end up receiving more money for 

his stock by exiting at the current price. 

Client 

Page7


Flipside to the dark pool is that there is little way for sellers to assess whether they have received the best 

possible execution on the order, especially the case if the broker has "internalized" the order – i.e. match 

the order within their own shops, operating beyond the vision of other dealers and outside the spotlight of 

the SEC and use of technology / development of crossing networks has greatly expanded the in-house 

opportunities and through this we can observe a consolidation in the brokerage industry. 

The trading process over the dark pool is very highly dependent on information availability, accuracy of 

data and lead times between order and delivery - this can be abridged only through the use of 

teachnology. Technology if used positively can play to a trader’s advantage in seeking benefits through 

dark pool trading. 

Technology Existance: 

The below diagram indicates how technology plays an important role in this different trading mode; The 

strategy server indicated connects with various broker networks enabling it to accept requests from 

various broker dealer networks and compare and match orders within. 

Alternate Trading Systems (ATS) include crossing networks, such as independently owned Liquidnet and 

Pipeline that match orders for execution without having to first route them to an exchange or market 

center where they could be viewed publicly. Besides enabling investors to execute an order without 

affecting the public price quote, crossing networks match orders at a specified price, typically the midpoint 

of the bid and ask prices on stocks at the point in time of the trade. Electronic communications networks 

(ECNs), which trade stocks and currencies, are another type of ATS. 

Firms such as Goldman Sachs, Morgan Stanley, Charles Schwab and others have giant order flows - 

They are obviously best positioned to fill orders in-house. They profit off a spread between the price they 

paid for a stock and the price they charge the buyer. While initially they are likely to seek narrow spreads 

so as to attract business, if there is a fall-off in the number of competitors, the spreads will likely widen 

Page8


Table below indicates different broker dealer owned dark pool networks that are operational; 

How do they impact the current Market? 

A number of market center and major brokerage firms are engaging in transactions of large bulk orders 

through efficient transaction modes like ECN’s and benefiting through anonymity and lower transaction 

costs and also at the same time not impacting the market position. 

It is observed that strategic dark pool routing can provide for more efficient and potentially more profitable 

trading with minimal impact to Market prices without sacrificing anonymity. 

Therefore, with more and more brokerage houses and other institutional investors taking the dark pool 

trading model when it comes to large blocks, the actual liquidity in the market could get impacted and 

trading volumes could get lower by the day in the exchanges. This would start affecting the market 

liquidity position slowly and could call for serious consideration towards the volumes that could be traded 

over these dark pools. As a result there could be fragmentation in the market with the growing popularity 

of these dark pools. 

Fragmented Markets perspective to dark pools 

Dark pools would in turn bring in fragmented markets as feared by most members. 

Page9


In order to counter this the regulatory changes by the way of REG NMS brought in that any ATS that 

controls more than 5% of the daily average volume of a particular security over 4 of the preceding six 

months period must provide open quotes to the market. 

But dark trading pools, allow market participants to take a position on a stock without expressing it in the 

public, transparent stock markets. And, since these markets are not regulated, and therefore not 

transparent, insider trading seems likely. 

And even without insider trading, participants in dark pools could be trading on information which is not 

available to the public markets. This would give rise to differences in price. Which would give rise to 

arbitrage opportunities. 

Point to wonder - could this have happened in the current Indian market scenario as well with investors 

losing high value over the last few months? Certain large investors exiting the markets leading to stock 

having steep falls in its price thereby viping out liquidity in the market 

Now,lets try and counter this problem and see if there is a work around to this - This situation could be 

resolved in one of three ways; 

One, the financial institutions that run dark pools will be true to their word and mark dark pool prices to the 

public markets at all times – this will be too much to expect of them. 

Two, this would give rise to opportunities that traders would be compelled to take advantage of dark 

pools, and in order to take advantage of these opportunities they would have to take positions in public 

markets, which would then mean, theoretically, brings the black pool information to the public prices. If 

this process happened quickly enough, the difference in prices between the two markets would be 

arbitraged away. 

Third outcome to this situation, that prices remain different between the two markets for significant periods 

of time. 

In above cases either the public or the private market would be right about the direction in price, but 

certainly not both, and someone would lose money. And one would assume (although it’s certainly not 

guaranteed to be true), that dark pools would have the better information, since dark pools are only open 

to the privileged (i.e. better informed). 

Page10

Technologies that cater to this industry needs 


Electronic Communication Networks (ECN’s) industries catering to transactions in dark liquid pools are 

active with consolidation and ever-changing competition. There have been several developments and 

acquisition in this space to reach out to those clients interested in such requirements. Today ECN’s are 

routing to their orders towards other ECN’s and exchanges making the trading space more wider and 

thereby enabling higher reach with reduced costs of transaction. 

Firms are accessing dark pools via point to point connections by means of managed network partners 

enabling them to access multiple dark pools simultaneously and also eliminate multiple connections. 

Software vendors can have solutions & offerings 

Some service lines that can relish working on dark pools; In the near future technology companies will 

have significant role to play in enabling more & more players entering this space in search of more 

liquidity. Some areas that may utilize immediately attention of software services are listed below; 

Technology Infrastructure Services – 

Ł Services like improve hardware utilization, storage management, physical server consolidation, 

Ł Increased availability of data & lowering data center operating costs, Identity and access mgmt. 

Ł Upgrade of existing systems for improved performance and reduced downtimes 

Application Development & Maintenance & Testing – 

Ł Trade matching engines, market data systems, reference data systems 

Ł Development of order routing / matching engines etc…application rationalization 

Ł Algo trading systems & mactching & reconcilliation systems, 

Technologies - 

Ł Web services / SOA, XML, server Virtualization (Vmware), 

Ł VoIP, network access controls, software as a service (SaaS), 

Ł Open source development, moving platforms to linux and saving license costs 

Key risk management initiatives in the dark pool arena 

Risk: 

v Risk hedging systems 

Page11


v Systems that track risk and indicate aggregated risk in views 

Costing: 

v Transaction costing systems – since most trades here happens in higher volumes 

v Commission management systems 

New Development: 

v CRM systems for HNI customers 

Conclusion & way forward >> 

Dark pools provide liquidity and anonymity and it is unlikely that they will go away, since they play a 

valuable role for large financial institutions. They allow them to make large trades anonymously and to 

express an opinion about a stock without tipping off anyone else what that opinion is. 

Or, in other words, they can keep their valuable information to themselves and gain benefits from using 

this piece of information 

With the growing number of dark pools, and regulators keeping their eagle eye on these trading patterns, 

it could be not so long before that the information over the dark pools be made public over the same time 

as the exchange. i.e, trading volumes are disclosed as per normal trading proceures. Over the last 6 

months some broker dealer networks have shown an inclination towards this model with Wall Street 

banks Goldman Sachs, Morgan Stanley and UBS have agreed a series of bi-lateral agreements that will 

allow their US clients to access each bank's dark liquidity pools. 

The need for gaining access to the growing number of dark pools of liquidity has resulted in the 

development of new technology and systems for both broker-dealers as well as from the institutions side 

to implement systems to place orders ensuring business opportunity. 

Broker dealers need to enhanse various systems to be able to do a series of activities and provide the 

requisite technology and business support to their clients 

• Order routing 

• Interaction flows & methodology 

• Negotiation procedures 

• Spliting & matching algorithms 

• algorithmic trading in other areas FX, listed options, fixed income 

Morgan Stanley today uses NightOwl, a new electronic trading tool that navigates select dark liquidity 

pools and quoted markets to provide clients with access to the most natural liquidity possible. 

Finally, as more investors rely on complicated algorithms / platforms & rules engines to perform the 

market making functions that were once the province of the specialist, the transparency of the market 

place will be forever diminished or hidden behind the large boxes of machinery/ servers. 

Ł The future trade will eventually move towards predefined algorithms & artificial intelligence settings 

that one is able to achieve - providing an individual / firm that competitive advantage to stay ahead of 

competition, 

Ł Technology service providing companies have an instrumental role in providing the necessary 

configuration to enable these companies trade over these platform/networks in an efficient manner. 

Page12

Acronyms 

• Electronic Communication Networks (ECN’s) 

• Service oriented architechture(SOA) 

• Customer relationship managament(CRM) 

• High networth Individuals(HNI) 


References 

1. Securities Industries news 

2. Wikipedia & other search engines 

3. NCFM - NSE's Certification in Financial Markets (NCFM) study materials 

4. Websites of broker dealer networks companies – Goldman Sachs, Morgan stanley & UBS 

5. Finextra 

Acknowledgements 

• I would like to take this opportunity to thank Santosh Satpathy for his support and 

encouragement in making this white paper. 

About the Author 

• Ravikiran Achuthakumar, Business analyst with wipro technologies over the last 18 months has 

been working with the solution Design team for the securities and capital markets vertical. 

Working with several accounts in the vertical towards business growth and also in coordination 

with the wipro sales team in identifying new prospects and increasing wipro business spectrum 

and adding to wipro organzational objectives. 

About Wipro Technologies 

Wipro is the first PCMM Level 5 and SEI CMMi Level 5 certified IT Services Company globally. Wipro 

provides comprehensive IT solutions and services (including systems integration, IS outsourcing, package 

implementation, software application development and maintenance) and Research & Development 

services (hardware and software design, development and implementation) to corporations globally. 

Wipro's unique value proposition is further delivered through our pioneering Offshore Outsourcing Model 

and stringent Quality Processes of SEI and Six Sigma. 

Wipro in Securities & Capital Markets 

Wipro’s Securities and Capital Markets vertical helps leading Investment Banks, Investment Management 

firms and Stock Exchanges in the world with state of the art technology solutions to address business 

priorities like operational efficiency, cost optimization, revenue enhancement and regulatory compliance. 

Wipro has dedicated domain practices (250+ Business Analysts) focusing on providing solutions in the 

Buy Side (Asset Management), Sell Side (Brokerage) and Exchange / Marketplace domains. Our domain 

teams engage with customers in developing solutions that include custom application development, 

product based solutions, Business Process Outsourcing and process mapping and reengineering in order 

to help out customers to obtain maximum service efficiencies 

http://www.wipro.com/financesolutions/securities/index.htm 

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