Some economists have long decried the existence of so-called "dark pools," or off-market trading exchanges that are beyond the jurisdiction of federal financial regulators. Supporters of these networks argue that dark pools are required for investors to help offset certain types of risk, but a growing body of evidence suggests that these private trading areas are actually increasing the inherent level of risk in the market.
A report recently conducted by The New York Times suggested that at least of 40 percent of all trading activity takes place in dark pools. One of the biggest problems with these developments is that overseers from the U.S. government don't have a comprehensive set of policy tools to fully regulate what is happening inside them or even gain a full understanding of how these trading systems work. The Times piece cited an Australian study conducted earlier this year by researchers for the Pacific Ocean nation's largest public exchange, ASX Ltd., which established a correlation between rising dark pool activity and higher prices for a wide range of asset classes.
"If long-term investors are being siphoned off and sent away from the [public] exchanges, there will be less competition and prices will get worse," Daniel Weaver, a Rutgers economist who has worked on the issue, told the newspaper.
Use of dark pools harms trust in the markets, experts say, because participants with smaller capitalization levels are unable to accurately judge how prices and trends are going to change on a given day. These off-exchange trading groups also raise the specter of insider trading, as its nearly impossible to see who is actually selling or buying and how these individuals are communicating.
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