1. Market Structure
U.S. Equities

2. Issue of transparency Exchanges, dark pools, and internalization
Differ in pre-trade transparency
All have post-trade transparency
Exchanges
Once trade is executed, it is immediately reported to the consolidated tape, and published
Dark pools
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3. Traditional exchanges
Electronic limit order book markets (e.g., NYSE, TSX)
Bid and ask prices, size of the orders are posted
Buyers and sellers need to “cross” the bid-ask spread for a transaction to take place
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4. Electronic Communications Networks (ECNs)
Example of Alternative Trading Systems (ATSs)
Similar to exchanges, but do not provide:
Listing services
Market surveillance, oversight responsibilities
Active in the 1990s, but many have been acquired by exchanges
Instinet, now part of NASDAQ
Archipelago, now NYSE Arca
Today, one major stand-alone ECN left (LavaFlow)
< 2% of volume
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5. US Exchanges, March 2012
Source: CFA Institute Market Structure report 2012
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6. Dark Pools Registered as ATS for regulatory purposes
Lack of pre-trade transparency
Orders are not fully displayed to others
Different shades of darkness
Complete darkness
Security, size of order, buy or sell, but no price
Orders are matched anonymously
Benefits to buyers/sellers of securities
Hide information
Reduce market impact of the trade
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7. Dark pools Benefits (cont’d) 16 dark pools in the US as of March 2012
Reduce trading costs - system may cross offsetting customer orders at the midpoint of the nation best bid and offer (NBBO)
Can restrict access to certain market participants (e.g., high frequency trading firms)  discriminatory
16 dark pools in the US as of March 2012
Ranking by size: Credit Suisse Crossfinder, Goldman Sachs Sigma X, Knight Link, Getco GETMatched, Barclays LX, Deutsche Bank SuperX, UBS PIN, Morgan Stanely MS Pool......etc.
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8. Internalization
OTC market makers internally execute order flow against their own accounts
Account for almost 100% of all retail market order flow (some limit orders may be routed to exchanges)
May or may not be related to the retail brokerage firm
Large retail brokers have their own OTC market makers
Small retail brokers have an order flow agreement with several market makers (who pay the brokers  $ per share)
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9. Internalization No pre-trade transparency to other market participants
Examples: Proportion of market orders in NYSE stocks routed to OTC market makers (in %)
Retail Brokerage
OTC Market Maker
E*Trade
Charles Schwab
Edward Jones
Citigroup Global Markets
5.2
0.1
18.2
Knight capital
8.4
13.4
Citadel
17.1
0.2
30.0
UBS Securities
7.4
99.7
6.1
E*Trade Capital Markets
61.9
32.2
Total
100.0
99.9
Source: CFA Institute Market Structure report 2012
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10. Internalization “Issue of preferencing” 15/11/2018
Source: CFA Institute Market Structure report 2012
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11. Transparency Exchanges Dark pools Internalization
Pre-trade transparent
In the US, account for 2/3 of volume
Dark pools
Not pre-trade transparent
In the US, account for 8-13% of volume
Internalization
In the US, accounts for 18% of volume
Issues: fairness - incentive to provide quotes, speed of price discovery due to fragmentation
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12. Post-trade transparency
Exchanges, dark pools, and internalization
Differ in pre-trade transparency
All have post-trade transparency
Exchanges
Once a trade is executed, it is immediately reported to the consolidated tape, and published (real time)
Off exchange trades
Trades are reported to a Trade Reporting Facility (TRF) through FINRA in the US, IIROC in Canada (within 30 sec)
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13. Smart order routing example
Portfolio manager
Investment bank
For institutional clients
In this example, first to dark pools, then to exchanges
Sell 15,000 shares of XYZ
Sales and trading
Routing logic:
Dark pools
Exchanges
Dark pool 1
5,000 shares available
Dark pool 2
5,000 shares available
Dark pool 3
3,000 shares available
800 shares
700 shares
500 shares
Exchange A
Bid size: 2,200
Exchange B
Bid size: 1,500
Exchange C
Bid size: 800
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14. Final note
According to Regulation ATS, introduced in 1998, if an ATS executes > 5% of the trading volume of a stock, then must provide pre-trade transparency
But according to the SEC, this threshold has not been met
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