If You Cannot Beat The Dark Pools, Join Them

Dark pools of liquidity are back in the news again. See a previous WSJ article, along with two recent posts (here and here) for more background. As reported in a recent Financial Times article, the stock exchanges themselves may now be willing to throw in the towel, and begin looking for ways to work with the dark pools. The reason is obvious. Dark pools currently represent about 12% of all U.S. stock trading, and the exchanges are looking for ways to get this volume back. There is also the implicit admission that dark pools are not a passing fad, given that many of the exchanges are also developing their own dark pool trading environments. In addition to the threat of individual dark pools, of which there are now approximately 40 such pools, the exchanges are also worried that some or all of the individual dark pools currently in existence will get together and form their own exchange. Nothing focuses the business mind like the potential of a new, stronger competitor.

As I have written before, it does not surprise me that such pool of liquidity are developing as more hedge funds (which are also growing in numbers) look for greater trade protection. No one wants to have others front-run you while you are entering or exiting a large position. On the other hand, it is still amazing to me that more traders, investors, regulators, and members of Congress are not more concerned about such pools, or discussing what impact they may be having on price discovery. Not that I welcome such intervention by Congress, but I suspect that after the housing mess, credit concerns, and the reason for high crude oil prices (i.e., speculators) are off Washington's hearing list, dark pools may begin to see a little more light. How this story ends - unfortunately - is probably not that difficult to predict.