by Leslie Boni, David C. Brown and J. Chris Leach.


On Oct. 10, 2012, new rules went into effect in the Canadian equity markets to regulate dark liquidity.1 Among the provisions is a requirement that any order that executes against dark liquidity must receive price improvement (i.e., execute strictly within the national best bid and best offer). Some exceptions are permitted, including one for large orders. The exception permits large orders—for more than 50 standard units or more than $100,000—to be executed without price improvement at dark (non-displaying) venues.
The Canadian regulators indicated their willingness to consider an exception for large orders in their 2009 Consultation Paper 23-404 “Dark Pools, Orders, and Other Developments in Market Structure in Canada”2:
Traders largely use Dark Pools to ensure anonymity and to minimize market impact costs… When information is leaked about a large order before it is executed, these costs can increase significantly. Dark Pools may decrease the opportunity for information leakage to occur by eliminating intermediaries.3
In Boni, Brown, and Leach (2012), we analyze whether attempting to exclude intermediaries (brokers, high frequency traders, etc.) has any impact on execution quality. Our analysis examines large U.S. equity executions of at least 50,000 shares at dark-pool provider Liquidnet, other dark pools, and order-displaying venues. Intriguingly, Liquidnet offers its institutional investor clients access to several dark platforms. One platform intends to restrict trading to only institutional investors (hereafter the “exclusive” dark pool). Intermediaries operate in a separate dark platform, and institutional investors have the choice of whether to participate in that pool as well. Institutional investor volume transacted on the exclusive dark pool dwarfs that of the broker-accessible platform.
We document evidence that the Liquidnet dark pool specifically designed to foster institutional investor exclusivity exhibits statistical regularities consistent with higher execution quality for large trades. Specifically, we analyze serial correlation in returns before and after the large executions, volume and volatility prior to the large trades, and large trade clustering across days.
We find a lower magnitude return correlation around large trades at the exclusive dark pool, consistent with a positive relationship between execution quality and dark pool exclusivity. Similarly, we document a lack of significant volume or volatility increase prior to large trades at the exclusive dark pool. Other dark pools and order-displaying venues exhibit significant increases in volume and volatility above those at the exclusive dark pool, possibly due to the leakage of order-flow information and related front-running. Finally, we document greater inter-daily large trade clustering at the exclusive dark pool. This is consistent with traders’ willingness to trade boldly and sequentially, presumably due to a perception of higher execution quality. Our findings are consistent with less pre- and post-trade exploitation of order-flow information at the exclusive dark pool.
The differences are not due to lower trade difficulty at the exclusive dark pool. Comparing trades with similar ones at other dark pools, executions at the exclusive dark pool are more difficult, at least if difficulty is calibrated by the large trade’s volume share (trade size divided by average daily volume) or the security’s liquidity as proxied by average daily volume.
Our finding of higher execution quality need not imply superiority in overall execution for the exclusive dark pool. It is worth noting that although we have execution-level data, we do not have order-level data. Thus, we are unable to determine the execution probabilities for large orders submitted to the various venues. Excluding intermediaries likely decreases the probability that a counterparty meeting the trader’s time and price constraints will be found. We also lack data for access fees, liquidity rebates, and broker commissions. We are therefore unable to determine how the trader’s “all-in” costs vary by venue. These are important questions for future research.
In 2009, the U.S. Securities and Exchange Commission (SEC) argued for exempting “certain narrowly targeted Indications of Interest (IOIs) related to large orders” in possible future dark pool regulation:
These size discovery mechanisms are offered by dark pools that specialize in large trades. In particular, the proposal would exclude IOIs for $200,000 or more that are communicated only to those who are reasonably believed to represent current contra-side trading interest of equally large size. The ability to have a method for connecting investors desiring to trade shares in large blocks can enable those investors to trade efficiently in sizes much larger than the average size of trades in the public markets.4
Our findings suggest that if regulatory intent is to facilitate matching for “contra-side trading interest of equally large size,” then direct treatment of the trading population can be advantageous, even after providing exemptions based on trade size. We conclude that excluding intermediaries, and creating an environment explicitly fostering trading among natural counterparties, can improve large trade execution quality. Dark pool design matters. Not all dark pools are created equal.
1) Investment Industry Regulatory Organization of Canada, 2012. IIROC Notice 12-0130 – Rules Notice – Notice of Approval – UMIR – Provisions Respecting Dark Liquidity, available at http://docs.iiroc.ca/DisplayDocument.aspx?DocumentID=77C 0AF22004E417D9217A160B3FCB5C5&Language=en.
2) Canadian Securities Administrators and Investment Industry Regulatory Organization of Canada, 2009. Joint CSA/IIROC Consultation Paper 23-404 “Dark Pools, Dark Orders, and Other Developments in Market Structure in Canada,” available at https://www.osc.gov.on.ca/documents/en/Securities-Category2/csa_20091002_23-404_consultation-paper.pdf.
3) As early as the 1980s, researchers highlighted the risk of information free-riding as a potential problem for institutional investors who try to use intermediaries for the executions of large trades of NYSE-listed stocks in the upstairs market. See Burdett and O’Hara (1987).
4) Securities & Exchange Commission, 2009, “Fact Sheet: Strengthening the Regulation of Dark Pools,” available at http://www.sec. gov/news/press/2009/2009-223-fs.htm.


Boni, L., D.C. Brown, and J.C. Leach, 2012, “Dark Pool Exclusivity Matters,” Working Paper, University of Colorado at Boulder.
Burdett, K., and M. O’Hara, 1987, “Building blocks: an introduction to block trading,” Journal of Banking and Finance 11, 193–212.