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Unlike traditional stock exchanges like the NSE or BSE, dark pools are more discreet, and the orders are not visible to all participants.
This article explains what dark pools are, how they work, their legality, and the advantages and disadvantages of the forum.
Key Takeaways
- Transactions on dark pools are not made public until the trade is complete.
- Dark pools are not available in India, unlike Europe or the US.
- According to guidelines by the Securities and Exchange Board of India (SEBI), all trades must be reported in real time, resulting in greater transparency compared to dark pools.
- Large investors may get shares at a better price in dark pools compared to regular exchanges.
- If big traders conduct transactions privately among themselves, it can lead to lower liquidity in the public markets.
What is a Dark Pool in Trading?
In trading, a dark pool is a private exchange or forum where large investors, such as pension funds, mutual funds, and large financial institutions, buy and sell stocks. The trades in dark pools are hidden (or “in the dark”) until the transaction is complete, giving the exchanges their name.
Dark pools allow large trades to occur without a sudden jump or drop in stock prices, helping prevent market volatility.
Imagine someone wanting to sell stocks worth ₹150 crore on NSE. If a large order like this is placed on a public exchange, panic occurs. Prices would crash even before the order is fully executed. Dark pools help prevent such instances.
Types of Dark Pools
Three main categories of dark pools exist in today's markets.
- Exchange-owned: Traditional exchanges can launch their own dark pools in order to compete for institutional order flow. The portals often offer better integration with public exchanges. They can provide extra services such as algorithmic trading support.
- Broker-dealer-owned: These dark pools are operated by major financial institutions and primarily serve the operator's clients. They often internalize order flow from retail and institutional customers.
- Independent: The dark pools are run by third parties. These are neutral venues that do not favor any particular broker or exchange. The platforms often specialize in specific asset classes or trading strategies.
How do Dark Pools Work?
Let’s say a pension fund wants to buy 50 lakh shares of a listed firm. If the fund conducts the transaction on a public exchange, it might take time and affect the stock price as well.
The fund uses a dark pool instead of placing a buy order. There might be another big institution wanting to sell those shares on the platform. If both parties agree on the price, the transaction is conducted without affecting the public market.
Once the deal is completed, the details are reported to the regulator. By then, the market has moved forward, meaning the trade does not disturb public prices too much.
How are Dark Pools Different from Regular Exchanges?
| Feature | Regular Exchange (e.g. NSE, BSE) | Dark Pool |
| Visibility | Public and transparent | Hidden until after the trade |
| Users | Retail and institutional | Only institutional investors |
| Price Impact | Can be high, resulting in market volatility | Minimal impact |
| Regulation | Strictly regulated by SEBI | Not allowed in full form in India yet |
Are Dark Pools Legal in India?
In India, dark pool trading is not permitted in the Western form. Instead, the SEBI mandates real-time reporting for large institutional transactions executed through domestic equivalent mechanisms, such as block and bulk deals.
Block and bulk deals, similar to dark pool trades, are allowed in India. A block deal runs in a dedicated window while a bulk deal happens on the regular market. A minimum order value and price band are required for a block deal.
| Feature | Block Deal | Bulk Deal |
| Time of trade | Requires a dedicated window, either 8:45 - 9:00 AM or 2:05 - 2:20 PM | Conducted in the regular market during normal trading hours |
| Reporting timeline | End of a specified timeframe | At the end of the same trading day |
| Regulatory requirements | Minimum order value ₹25 crore as per SEBI’s latest guidelines ±3% in terms of price | If the trade goes beyond 0.5% of the company's shares, it has to be reported to the stock exchange |
| Participants | Institutional investors, large corporates, and high-net-worth individuals take part | Both individual investors and institutional entities can take part in such transactions |
| Purpose | Undertaken to fulfil certain goals, such as adjusting exposure to a specific sector | Reasons include portfolio rebalancing and institutional investing |
Tax Treatment
Shares bought or sold via a block or bulk deal are taxed just like any other market transaction. They are subject to capital gains and Securities Transaction Tax based on the holding period.
Advantages of Dark Pools
Dark pools provide the following advantages to institutional investors:
- Avoid market impact: Executes large volume trades quietly away from public order books, protecting the privacy of buyers and sellers from premature price movement.
- Get better prices: Investors often get better execution prices for their transactions. Dark pools lower the costs of trading large volumes of shares.
- Faster execution: The buyers and sellers can be matched quickly in dark pools.
Disadvantages of Dark Pools
Dark pools also raise concerns about transparency and price discovery.
- Lack of transparency: Small investors remain unaware of trades that impact their holdings and are executed without their knowledge.
- Unfair advantage: Large players might receive better prices on stock transactions than retail investors.
- Market manipulation risks: Dark pools can be misused to hide conflicts of interest or to confer price advantages on the broker.
- Price discovery: Public stock exchanges depend on real-time prices. Hidden trades, like those conducted in dark pools, can reduce the accuracy of price signals.
Impact of Dark Pools on the Indian Market
India does not have dark pools, but private trades can affect the stock exchanges.
- Liquidity concentration: Large investors engaging in private trades among themselves can reduce liquidity in the public exchanges.
- Price changes: When block trades are reported after execution, they can result in short-term price fluctuations.
- Strategic trading: Companies and large funds can quietly build or exit positions using block windows.
Conclusion
A dark pool in trading is a private platform where large investors can conduct discreet trades involving large volumes of stocks. While the platforms raise concerns about transparency and market manipulation, they also help maintain price levels of a stock, especially during large trades. In India, similar methods to dark pools, such as block and bulk deals, are in place.
