October 19, 2011
I think that it's imperative that the SEC conduct a thorough review of Dark Pools Please see the following passage taken from a recent article in Forbes discussing Dark Pools.
"Dark pools are a private or alternative trading system that allows participants to transact without displaying quotes publicly. Orders are anonymously matched and not reported to any entity, even the regulators (Younglai and Spicer 2009). Thus, the mainstream exchange-traded market does not have any clue about the volume of transactions happening in this parallel market or the prices at which they are being executed. Obviously, price discovery on the mainstream market, without dark pools information, becomes inefficient. Moreover, transactions carried out in dark pools effectively become over-the-counter in nature as the prices are not reported and financial risks not effectively managed. More critically, these risks can spread like wild fire as we saw in collateralised debt obligations and credit default swaps markets."
Link to Article : http://www.forbes.com/sites/davos/2010/05/22/dark-pools-the-menace-of-rising-opacity-in-financial-markets/
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Dark Pools affect price discovery.
Effectively Dark Pools are Markets.
Their prices should be made public along with their volumes. Most investors rely on the exchanges to provide information on price. Price provides information about supply and demand and helps investors to make decisions.
Exchanges are good things as they provide sources of liquidity for the markets. Dark Pools are essentially exchanges. If Dark Pools are to be allowed, then ALL transactions occurring in a Dark Pool should be reported within a specified time window.
Dark Pool operators provide a source of liquidity to Hedge-funds and Portfolio Managers and Institutional Money Managers. By not requiring Dark Pools to report prices of all trades - markets do not really reflect all known information at any point in time. This is inefficient.
Dark Pool owners are assuming a certain amount of risk, which could ultimately have systemic consequences for markets. If a dark pool owner has agreed to provide a specific price to the ultimate seller and then assumes this risk - how is this risk priced ?
It's not. It's concealed.
If there was a systemic failure and the dark pool failed to make good on its' price guarantee to the ultimate seller, then it's conceivable that the dark pool may need a bailout to insure that the ultimate seller is made whole. If the dark pool is not bailed out, then there are potential losses that could exist for the ultimate seller and potentially the taxpayers.
I strongly feel that Dark Pools need to be regulated - they should have to post collateral with the government, just as a bank has to keep reserves.
They should be forced to report price transactions, just as exchanges do. I feel that all derivative trades should be publicly reported - failing to require this, results in markets that are opaque. This "darkness" will inhibit the free flow of trade - which is necessary to insure that markets are functioning properly to provide necessary liquidity.