Nov 302012

Dark pools of liquidity (dark pools) play a vital function in the equity marketplace and using them has become standard operating procedure, especially when executing large trades.  Unlike  traditional exchanges, dark pools provide market participants with trading venues where quotes (price, size, and side of an order) are not displayed. This in turn allows market participants to execute transactions anonymously with minimal information leakage, which makes dark pools a useful source of liquidity for raising equity capital.  In an at-the-market offering (ATM), traders must carefully balance the benefits of raising additional capital for clients with the costs of impacting stock prices.  Small cap stocks in particular can often have scarce amounts of liquidity available in traditional exchanges, which emphasizes the need to tap into additional sources of liquidity.  By strategically accessing these dark pools, capital can be generated with minimal price impact and information leakage.

Another key benefit for issuers raising capital with an ATM is that dark pools frequently provide price improvement.  When there is a match between a buyer and seller, the transaction typically occurs between the bid and the ask prices.  This feature can be especially useful for issuers whose stock has wider spreads, as these small price improvements in dark pools can accumulate significantly over time.

As dark pools continue to increase in market share and popularity, it is also important to understand the nuances of their business models.  With dark pools being owned by broker-dealers, consortiums, and exchanges, orders can be executed based on a variety of different frameworks, including being paired off with a disproportionate amount of high frequency trading volume.  Traders should be cognizant of these contrasting market structures and analyze executions with post-trade forensics as frequently as possible.  When monitored closely, dark pools are effective venues for raising capital through at-the-market offerings.