Market Microstructure in Emerging and Developed Markets

CHAPTER 12

Dark Trading

HANS DEGRYSE

Professor of Finance, KU Leuven—University of Leuven and Tilburg University and CEPR

GEOFFREY TOMBEUR

PhD Student, KU Leuven—University of Leuven

MARK VAN ACHTER

Assistant Professor of Finance, Rotterdam School of Management, Erasmus University

GUNTHER WUYTS

Professor of Finance, KU Leuven—University of Leuven

INTRODUCTION

Driven by technological innovations and regulatory changes during the last decades, trading venues nowadays compete more intensively to attract investors' order flow. Where investors used to be constrained to trade in the local exchange, they now face a wide array of trading systems where they could fulfill their trading needs. For instance, investors may opt to submit their orders to a venue that operates as a continuous limit order market (e.g., an electronic communication network [ECN] or in Europe a multilateral trading facility [MTF]). Other alternative trading systems (ATSs) are darker in nature (i.e., they are characterized by low or absent pretrade and posttrade transparency). Examples include over-the-counter (OTC) trading, broker-dealer internalized trades, and dark pools. This chapter focuses on dark pools.

Dark pools are trading venues that do not publicly display their orders. The benefit of using a dark pool is that orders remain hidden and investors can avoid the price impact of trades and front-running by brokers. As this is a particular concern for large institutional orders, dark pools were originally designed ...