The Mystery of Dark Pools May Become Clear

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Dark pools may seem dark, mysterious and maybe nefarious for those who don’t play on the Forex market.

But as ominous as the term “dark pool” sounds, it’s really not as scary as it sounds.   And with regulatory changes of the Volcker rule on the horizon these “off exchange” transactions may become more transparent.

Simply, dark pools are venues where trading is done off of an exchange to obtain price improvement.    “Dark liquidity” pools also help institutions execute large transactions that could have an impact in the public markets.   In other off exchange trades, broker-dealers, and other players use dark pools to match institutional orders.    Of course, market participants are not required to disclose their identity before the deal goes down.    But that information does become public afterward.

Nowadays, however, dark pools have evolved so that retail investors are being drawn into the game through high frequency ETF’s.   The trades give retail investors a chance to get price improvement and better liquidity.   At the same time, some investors may not have the savvy to swim in these waters.    Even worse are the bad market players who lure people into the deep end of a fraudulent pool.

But with the Volcker rule pending and other agency concerns looming, off exchange transactions are about to be subjected to greater scrutiny.    In fact, SEC Commissioner Mary Schapiro said last year that trading in dark pools is affecting pricing transparency in the public markets.    Moreover, recent CFTC enforcement actions against foul players in the Forex sector are shedding new light on these trades.

And the inevitable restrictions that will come by way of the Volcker rule, along with the possible establishment of clearing houses for these transactions, will subject this sector to enhanced regulatory scrutiny.

In the meantime, dark pool players are advised to use “good faith” to ensure their current deals can stand up to regulatory fire of the coming Volcker rule.    Until then, be careful where you swim.

(Kyle Colona contributed to this story)

Anna Timone (195 Posts)

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