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Creature from the Dark Lagoon: Regulators Seek More Light for Dark Pools

  • By Elizabeth Johns
  • Published: 2009-11-01

From 'The Bottom Line' in the November issue of Exchange, the AFP member magazine.

Just when you thought it was safe in the water, more information has surfaced on pools of liquidity that are equity based.

Here in Washington last month, the Securities and Exchange Commission voted to seek more transparency into so-called dark pools, the huge institutional blocks of equity trades that operate invisibly without public buy or sell quotes.

Initiated among traders many years ago, the concept of dark pools was intended to protect markets from the swings that might occur if large investors were known to be making dramatic moves.  The biggest pool is run by Goldman Sachs under the alien sounding name, SigmaX, and there are many others.

Since 2002, the number of dark pools that encompass stocks from major U.S. exchanges has tripled, says the SEC in a fact sheet -- an eerie suggestion that something ominous is lurking outside our vision.  This invisible creature may grow to 1.5 billion shares daily by 2010, according to calculations by TABB Group, the consultancy.

At a time when banks are under fire, critics say that banks and other institutions might be profiting from the secret information. And who knows what effect these dark pools might have on market volatility in the future, but it could be scary.

So the SEC is suggesting that there be more transparency before and after a dark pool trade occurs, and that the trading volume threshold that would trigger information on alternative trading systems decrease so that more information is available, and they are seeking comments on this.

Meanwhile, the Canadian Securities Administrators and the Investment Industry Regulatory Organization of Canada have launched a joint initiative to study dark pools, and there is parallel debate in Europe.

While transparency seems sensible, investment banks argue that the pools provide liquidity and market efficiency. Others say that over-regulation might backfire and result in lower prices for the public, especially for pension funds and mutual funds, which are the main source of retirement security for many of us.  In other words, are the pools themselves the makings of a horror movie, or is the real danger trying to exert control and disrupting one's own reflection in the water?

Elizabeth Johns is a managing director with AFP.'The Bottom Line' appears monthly on the last page of Exchange magazine. See last month's column: More on Floating NAVs

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