LONDON The benefits of dark pools, where investors can trade shares anonymously, outweigh the risks, an analysis from Britain's markets watchdog said on Thursday.
Dark pools, which feature in Michael Lewis's best-seller book "Flash Boys", have come under fire from some financial experts who say they are poorly regulated and that traders working in them do not always get the best price for customers.
In January, Barclays and Credit Suisse banks settled federal and state charges in the United States that they misled investors in dark pools. The European Union, meanwhile, is introducing a cap on trading in dark pools from January 2018.
However, Britain's Financial Conduct Authority (FCA) said its analysis showed dark pools could provide important benefits.
Some investors like using dark pools because other players cannot see when they are executing larger orders. On public exchanges, traders can see a large order going through, and so can move the price against the investor conducting it.
Trading in Europe's dark pools hit nearly 100 billion euros (75 billion pounds) in June, the highest on record, according to Thomson Reuters Market Share Reporter. This is still only a fraction of overall equity trading turnover, though, which reached 2.3 trillion euros in the same month.
Dark pools execute orders using prices from public exchanges such as the London Stock Exchange (LSE) as a reference.
A major criticism of dark pools is that some of the prices in them are "stale," meaning they lag those on public exchanges. That matters because trading venues are legally required to offer "best execution" to customers, though sometimes a stale price can be better for the investor than an updated one.
In the first analysis of its kind in Britain, the FCA said "stale" bid and offer prices existed in every dark pool it sampled in Britain and their prevalence had risen to just over 4 percent of dark trades in June 2015 from 3.36 percent in 2014.
On peak days, stale trades can top 10 percent, it added.
The FCA analysis also found that high-frequency traders, or those who use computer algorithms to nip in and out of markets at ultra fast speeds, were on the profitable side of stale trades in 96 percent of cases.
However, it estimated the cost to investors from stale prices was just 4.2 million pounds ($5.5 million) a year, a fraction of the 4.9 billion pounds average daily order book trading on the LSE.
"Overall, we find that the costs associated with inferior reference prices are small, and do not outweigh the useful service dark pools provide to market users by providing price improvement and reducing price impact," the analysis said.
Last week a group of asset managers and banks teamed up with the dark pool unit of the LSE's Turquoise arm.
(Reporting by Huw Jones; Editing by Mark Potter)