July 17, 2013

Data Darkness

There’s apparently a reality TV show called “Dating in the Dark.”

It must lack the cachet of Survivor or The Bachelor because you don’t hear much about it. The gist is that a number of people of opposite sexes wander around in utter blackness falling in love. You wonder how that’s superior to the displayed market – so to speak.

But in the equity market, dating in the dark is a big deal. I’m talking about how stock orders find each other. Take Coca-Cola (KO), which reported yesterday. From July 8-12, according to Fidessa’s Fragulator, 25.6% of trades occurred on KO’s listing exchange, the NYSE. But 29.4% were on the FINRA NYSE tape, a reporting facility for trades between brokers rather than on exchanges.

The remaining 44% of KO’s trading mostly met in displayed markets at the Nasdaq, BATS and Direct Edge, and the NYSE’s derivatives-centric platform called NYSE Arca, formerly the ECN Archipelago.

Why does this matter to you, IR professionals? It’s important to understand what’s happening. This is the market you manage – the equity market for your shares.

So, FINRA – the Financial Industry Regulatory Authority – is trying to address concerns that a large amount of stock-dating in the dark is bad for markets. That volume of KO’s on the FINRA NYSE tape? It’s “dark pool” trading, where buyers and sellers meet secretly and anonymously through brokers acting like millionaire matchmakers.

Last week FINRA sent a proposal to its members that would create new reporting rules for dark pools. If adopted, alternative trading systems, or facilities where the principal function is matching trades but the regulatory structure is one for broker-dealers rather than the regime exchanges operate under, would report their trades to FINRA on a delayed basis using a unique market-participant identifier. That way, FINRA would know what trades and volume occurred in each facility to better identify market-manipulation.

It’s ironic. The specialist on the old NYSE floor knew exactly which brokers were behind both sides of the trade. Regulators didn’t like that. A wave of rules designed to make markets more anonymous followed, and unsurprisingly, what we have are anonymous markets. Now, regulators want to impose rules to reduce anonymity. Hm.

Anyway, we are all for better data! No one has pushed harder for data that reflect how contemporary markets work – for issuers. But regulators used to be servants, referees, guardians of free function. Now they’re the police, less concerned about preserving freedom than controlling outcomes with every tracking tool.

How about first we make sure the participants themselves are informed? No constituency has been left more in the anonymous data cold than issuers. Public companies – unless they’re using our sophisticated model-driven analytics – have no clue what’s behind price and volume.

If dark pools must report their trades to FINRA, issuers should have that data, too. And how can dark pools be separated from other broker-to-broker order flow? It’s all off displayed markets.

We here at ModernIR have long argued that every public company should be able to add up trades by market-participant and see 100% of volume. Here’s the ultimate irony: When I was in the IR chair a decade ago on the Nasdaq, you could do that. Now, by comparison the data the Nasdaq supplies to issuers is a wobbly shadow of its old self (that exchange should be lobbying for better issuer data but it’s instead selling services to issuers).

Hands are wrung about threats to markets from dark pools – and nobody invites issuers to weigh in, the 3,600 entities whose shares increasingly trade there and without which there would be no market.

Still, there’s good news. Whatever rules FINRA adopts must go through the rule-making processes that all Self-Regulatory Organizations follow, permitting an open forum for comments and requiring SEC approval.

Go to finra.org. Watch for rules, and when the rule is filed, write a comment letter urging FINRA and the SEC – before anything else – to level the data playing field for issuers. I realize it seems futile because data efforts seem to come and go. Don’t give up.

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