The operators of anonymous stock trading venues called 'dark pools' defended their existence on Friday, but conceded they could be more transparent after the U.S. Securities and Exchange Commission warned they posed emerging risks.
The venues allow stock traders to hide their intentions and have come under increased scrutiny as they have grown, and as the United States scrambles to rewrite market rules and bulk up oversight.
SEC Chairman Mary Schapiro said on Thursday she was worried about the effect of dark pools on price discovery, particularly their use of pre-trade messages that tip off certain market participants to upcoming orders, adding the agency is considering taking action.
Dark pools have proliferated as markets have gone electronic. Some operators, which include big banks, told Reuters dark pools could adopt better trade reporting standards, but warned against new rules that would wipe out the benefits of having multiple trading venues.
If they do something that makes the dark pool light and eliminates the reasons for institutions to trade on our vehicles, that would be a disaster for a hundred million people out there, said Seth Merrin, chief executive of electronic marketplace Liquidnet, a dark pool used by buy-siders.
I'm definitely afraid of knee-jerk reactions, Merrin said in an interview, adding dark pools may need to improve the way they report trading volumes. But who knows what could happen in this environment.
The Obama administration unveiled sweeping financial reform plans this week promoting market transparency and regulatory oversight, following the worst financial crisis since the Great Depression.
The next day, Schapiro told a New York Financial Writers Association dinner the SEC, will be taking a serious look at what regulatory actions may be warranted in order to respond to the potential investor protection and market integrity concerns raised by dark pools.
Other SEC officials have raised similar concerns, but it was the first time Schapiro, who was sworn in to the powerful post in January, raised the dark pool issue in a speech.
The widespread practice of sending pre-trade messages, known as indications-of-interest, or IOIs, could spawn big private markets to which the public does not have fair access, the chairman said.
Chairman Schapiro opened up a whole other kettle of worms with IOIs, said Larry Tabb, chief executive of TABB Group, a research and advisory firm that tracks dark pools. Now the question is how do these actually work and do we really need to rethink how this information gets disseminated.
Tabb said the SEC could conceivably wipe out dark pools, but that would make it very difficult to trade large block orders and would drive up trading costs.
Liquidnet's Merrin added institutions would have trouble efficiently investing the assets they now manage, and that higher trading fees would eat into profits, if the SEC cracked down on dark pools.
New U.S. rules in the last few years forced exchanges and their non-displayed rivals to link up so investors get fair prices. There are now more than 40 dark pools representing an estimated 9 percent of trading in the United States, with Europe and other regions following suit.
Observers wonder whether the SEC will crack down on flashes and IOIs, require details on those who participate in dark pools, or simply mandate better trade reporting from the murky industry.
I'd agree that there should be more regulations on IOIs going out, said Whit Conary, president of dark pool LeveL ATS, which was launched in 2006 and is owned by Citigroup Inc
I don't think you have to over-regulate it, but at the very least a customer has every right to know if information on his order is being sent out.
Conary added in an interview the SEC is unlikely to ban IOIs, given the consumer demand for them, and that dark pools themselves are valuable because they allow competitive traders to take positions without impacting the overall market.
Several dark pools contacted by Reuters declined to comment on Schapiro's speech, noting the sensitivity of the issue.
Even before the recent explosion in dark pools, they long existed in the form of brokers on the New York Stock Exchange floor and in the networks of broker-dealer members of the then consortium-owned NASDAQ.
This month, Nasdaq OMX Group Inc's
(Reporting by Jonathan Spicer; editing by Andre Grenon)