Dark Pools—Opaque Off-Exchange Markets—Face Scrutiny

(October 22, 2009) – Dark pools, private and opaque electronic venues used to match trades anonymously, are the latest financial market to fall under the weary eye of the Securities and Exchange Commission (SEC), a development that could affect how institutional investors trade.

The SEC is proposing that these pools—the largest of which are Goldman Sachs’s Sigma X and Credit Suisse’s CrossFinder—lower the level at which they must report action in certain securities, from the current 5% of daily volume to somewhere between 1% and 0.25%. It also is calling for greater oversight of these traditionally murky markets that can make up 10% of daily trading volume in U.S. equities.

The main concern of regulators has been that these pools favor professional traders over more regular ones. However, some concerns have been voiced that institutional investors such as pension funds, which use the market to trade massive quantities of shares quietly, will be unable to do so under new regulations. Bloomberg, however, is reporting that large share blocks might well be exempt from the new disclosure percentages.

If this block trade exemption is passed, there is likely to be an upheaval in the pecking order of dark pools currently in existence. New York-based Liquidnet Holdings and Pipeline Trading Systems are currently two of the most popular venues for large block trades of more than 50,000 shares, and thus likely will  prosper. However, others—which can average as low as 450-share trades—likely will suffer.