What Is an Upstairs Market?
Let me tell you directly: the term upstairs market refers to a network that exists between large firms and institutional investors. This network handles large trades or block orders. These trades aren't submitted through a stock exchange, so they're not visible to other market participants. You see, these orders are carried out directly between buyers and sellers, with professional brokers acting as intermediaries. The size of these orders in the upstairs market makes up a big portion of the overall trading volume.
Key Takeaways
Here's what you need to know: the upstairs market is a network involving large firms and institutional investors. It deals with large blocks or high volumes of trade, all done off the trading floor. Intermediaries are often involved, which helps prevent insider trading. Remember, the upstairs market is the opposite of the downstairs market or stock exchanges. And regulators do monitor how trading in the upstairs market affects retail investors.
Understanding Upstairs Markets
Upstairs markets consist of networks of trading desks that handle large volumes of trades. We call these upstairs trades. Given the sheer volume, they're typically done by institutional investors like mutual funds, banks, pension funds, insurance companies, and brokerage firms.
As I mentioned, these trades happen off the trading floor, usually electronically or over the phone. The way they're conducted ensures no large swings or disruptions to securities prices in the market.
By routing trades through professional intermediaries—away from retail investors' eyes—this setup can prevent activities like front-running, where a broker uses inside information that affects a stock's price. Front-running can negatively impact the price or execution of a trade.
Special Considerations
These markets are sometimes called dark pools, which is where the phrase 'dark pools of liquidity' comes from. Dark pools are private financial exchanges, networks, or forums for trading activity organized between the involved parties. Just like upstairs markets, dark pools let investors make large trades without public disclosure. Although they might seem shady, dark pools and upstairs trades are completely legal.
That said, regulators are watching. As of 2014, upstairs market trades represented 15% of all U.S. trading activity, and that figure likely keeps growing.
Some authorities question if this practice undermines transparency and accessibility for retail investors, leading to stricter rules to cut down on dark pool trading. For example, Canada introduced regulations in October 2012 limiting when upstairs transactions can occur. Australian regulators did something similar in May 2013, causing a significant decline in upstairs-market volumes in both countries.
In the United States, regulators are also examining if this trading hurts retail investors and undermines overall activity. They've taken steps for fairness, like the Financial Industry Regulatory Authority (FINRA) initiative requiring weekly publication of trades on alternative trading systems (ATS), approved by the SEC in 2014.
Keep in mind: alternative trading systems allow off-exchange trading without enforcing participant conduct rules, which is why regulators monitor them closely.
Upstairs Market vs. Downstairs Market
If there's an upstairs market, you can bet there's a downstairs market. Since the upstairs market is a private network for institutional investors, brokerage firms, and intermediaries, the downstairs markets are simply stock exchanges.
Downstairs markets, or stock exchanges, create liquidity through trades by small investors, market makers, and floor traders. Unlike the large volumes in upstairs markets, downstairs trades are usually smaller. Trade details, including prices and amounts, are publicly available.
Advantages of an Upstairs Market
Consider this: if a hedge fund wants to unload a position in a security and submits a large sell order to the exchange, others might see it as a bearish signal, leading them to bid down the price and giving the fund a worse sale price.
The upstairs market benefits institutional investors with reduced transaction fees. By doing a large block order with one or a few counterparts, firms pay lower commissions than trading with many smaller ones.
In cases like program trades needing simultaneous executions, using upstairs market intermediaries might be the only effective way to carry out the strategy.
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