Competition good for investors: CFA

Markets best serve investors when there is strong competition between trading on lit and dark venues, says a study by CFA Institute.

In fact, increases in dark trading are initially associated with improving market quality, but when a majority of trading in a stock occurs in undisplayed venues, market quality deteriorates.

Read: Which equities suit boomers?

Further, the study suggests public policy should support fair competition and protect investors who display quotes in the public markets. Recommendations include:

• Internalization of retail orders should be required to offer meaningful price improvement, thereby generating economically meaningful savings for retail investors, and providing some protection to investors posting displayed orders on public exchanges;
• Regulators should monitor the growth in dark trading and take appropriate measures if it grows excessively;
• Dark trading facilities should voluntarily improve reporting and disclosures around their operations to enable investors and regulators to make more informed decisions over their use.

Read: Global trade to rebound: HSBC

“We believe implementation of these considerations would help protect displayed orders while offering meaningful savings to retail investors executing away from public markets, maintain competition, and improve transparency,” says Rhodri Preece, CFA, director of Capital Markets Policy, CFA Institute. “More fundamentally, these measures would enhance market integrity and lead to greater investor confidence in the equity market structure.”

Read: How to invest with intention

There were three main reasons for the report:

• The volume of dark liquidity has grown by nearly 50% over the past three years to account for nearly a third of consolidated volume in the U.S., with a similar amount in Europe. Thus, there is a clear shift in the market structure away from trading on transparent exchanges and towards dark, or undisplayed venues. An example: the launch in August of the New York Stock Exchange’s Retail Liquidity Program (RLP), which is an undisplayed trading system for retail orders.
• Regulators have voiced concerns over dark trading, including those in the U.S., Europe, Canada, and Australia, as well as the International Organization of Securities Commissions (IOSCO). The U.S. Securities and Exchange Commission (SEC) has considered regulatory proposals related to dark liquidity but has not passed any rules to date.
• Members of the CFA Institute Capital Markets Policy Council have raised concerns that the incentive to display orders in public markets is undermined by certain off-exchange trading practices, such as sub-penny trading in which broker/dealers fill retail orders ahead of displayed limit orders by offering price improvement in fractions of a penny.

Staff

The staff of Advisor.ca have been covering news for financial advisors since 1998.