Do ‘Dark Pools’ Threaten the Health of America’s Financial Markets?
NYSE Euronext and Nasdaq OMX Group - the corporate parents of the America’s biggest stock exchanges - headed to Capitol Hill this week to lobby regulators about a nefarious-sounding phenomenon spreading across Wall Street called “dark pools,” according to Bloomberg News.
There’s certainly no love lost between the New York Stock Exchange and Nasdaq, as these exchanges are bitter rivals competing over an ever-shrinking body of IPOs and order flow. So what are these dark pools, and why are they so threatening as to cause two foes to join forces?
While dark pools sound menacing, they are really just off-exchange forums where traders can buy and sell stock in private - without letting the broader market know what they’re up to. And these frameworks serve a simple purpose: to allow institutional investors who often manage huge portfolios to buy and sell large blocks of stock without causing price movements detrimental to those investors.
For instance, Pension Fund X might want to buy a big block of Exxon Mobil shares. Once word gets out in the market that a big pension fund is buying all these shares of Exxon Mobil, smaller funds will jump in ahead of it, causing the price to skyrocket and the fund to get a bad deal. A dark pool gives the fund a place to anonymously execute the entire order at once, and get the best price possible.
So what are the big exchanges all up in arms about? First of all, these pools are taking away their business. In an environment where trading levels are already down significantly, these dark pools are capturing an increasing amount of the exchanges’ erstwhile business. According to a recent Fox Business report, “as much as 40% of all trading now occurs off the exchanges, a sharp rise from just a few years ago.”