When dark pools first emerged, the possibility of an order being executed upstream of the exchange was noted but did not appear to be life threatening, as brokers have long sought to find the other side of the trade. Dark pools were not connected to each other, only some orders passed through them, liquidity was often patchy, and the market share of the exchanges was robust.

According to TABB Group's LiquidityMatrixTM, 5.3% of average daily volume is now being executed in the dark; and dark pool aggregation is hot. For as long as an order only passes through one or several dark pools on its way to an exchange, there is still a reasonable chance for the exchange to receive the order, but the wider the dark pool aggregation and the more traction they get, the higher the potential for execution upstream. The move by NYSE-Arca and Nasdaq to give access to the price improvement offered by dark pools is carefully crafted by the exchanges to reassert themselves in the execution chain and enter the dark pool aggregation space.

In the new model, the exchange will seek to match an incoming order against liquidity it already has on its books. Then the exchange will look at indications of interest that have been sent to the exchange by participating dark pools. If there is a match, the exchange will send out an order to that dark pool and expects a trade back within milliseconds. If still unexecuted, the order will be routed out to satisfy any away markets under Regulation NMS. While the new model is just starting out, it is likely to gain traction quickly while triggering a new round of competition amongst dark pool providers.

The most important point to note is that the order flow provider does not have to lift a technology finger, as the work to provide this access is being done by the exchanges and the dark pool operators. Every order flow provider on the street already has access to the exchanges, so there are no new connections to be made, no resources to be found, and minimal worrying about whether you should or shouldn't be using this function. The exchanges may offer slightly different methodologies, but essentially it is opt-out, so by default you are in. Some order flow providers will consider the routing charges warranted, to mitigate the cost and aggravation of having to deal with fragmentation, establish and maintain multiple connections, or choose aggregators.

Others may opt-out to reduce information leakage for an order of size, to avoid routing charges, or because the order may end up in a rival's pool. As far as rivals are concerned, the exchanges have a clear advantage over their members. Unlike the broker/dealers who will generally not connect to rival pools, the exchanges' perceived and regulated neutrality make them more sanguine about connecting to any dark pool, including those of other exchanges.

Orders are still going to pass through dark pools before they go to an exchange, but the exchanges have become senders - and therefore controllers - of dark pool flow as well as being recipients, and this will result in more competition amongst dark pools. NYSE-Arca is including a broad 29+ destinations; Nasdaq, by contrast, is limiting its connections to those that have perceived liquidity. If there are several dark pools competing for the same order, prioritization of routing will be based on performance monitoring of parameters such as response and fill rates, which will maximize the speed and limit any fishing expeditions.

At the very least, the dark pool access offered by the exchanges reduces the anxiety for the order flow providers of having missed the one pool with liquidity for that particular order. It will be interesting to see how quickly other exchanges adopt this business model, because they will have to if they are going to avoid being marginalized. This move by NYSE-Arca and Nasdaq is a well-choreographed repositioning in the execution value chain; and if it also results in dark pool providers increasing their efforts to stay upstream of the exchanges and on making sure they are competitive when positioned downstream, the order flow providers will ultimately benefit.

Miranda Mizen is senior consultant at Tabb Group.