Goldman Sachs executives have reportedly been toying with the idea of shutting down their dark pool, known as Sigma X.
“Dark pools” are to stock exchanges what private pools are to the Y. They are places for people to trade stocks in private, and many banks have them.
Privacy and Savings
There are benefits to having a dark pool, to be sure. Customers can trade more cheaply as they don’t pay exchange fees like they would on, say, the NYSE. For institutional investors, privacy can be critically important as well. For example, an institutional investor making a supersized buy order in the open would be noticed by sellers, who would raise the price before the order was even complete.
“Essentially, large institutional investors like this as a way of minimizing price impact and reducing trading costs,” says Craig Pirrong at the University of Houston.
Suspicion and Negative PR
However, there is also a great deal of suspicion over dark pools at the moment, as the flipside of privacy is decreased transparency. “There’s a considerable deal of regulatory uncertainty and legal uncertainty,” Pirrong says.
“Almost all dark pools work by taking prices from exchanges and filling orders based on those exchanges,” explains Larry Harris of the USC Marshall School of Business. So is it fair that a dark pool can use exchange prices, but not contribute to formation of those prices? Harris says: “And even worse, as the orders are taken away from those exchanges, the quality of the prices depreciates.”
Customers may see a conflict of interest as well.
“It might be better if people weren’t worried that I was only going to my dark pool because it was my dark pool,” says Joe Gawronsky, president of Rosenblatt Securities. It’s a bit of a PR problem.
A Liability Issue
Running a private stock exchange is no small feat. When participants’ expectations aren’t aligned with reality, or when prices in the pool become disconnected from prices on exchanges, it can be a serious liability for the entity running the pool.
“Particularly when there’s a fast moving, volatile market and the timeliness of the prices may be, for whatever reason, not appropriately reflective of the prices that were prevailing at the time,” says Andrew Karolyi, professor of finance at the Johnson School of Management at Cornell. This happened to Goldman in 2011, and the bank sent checks to cover traders who lost out as a result.
Gawronsky says firms like Goldman have alternatives. “There are other methods to get price improvement and hide your order other than using your own dark pool,” he says.
There are other entities’ dark pools, of course. There’s also IEX, an alternative trading platform designed to address what its founders argue are flaws in the structure of the U.S. equity market. Goldman has supported IEX precisely because of its commitment to transparency and market moderating effect.
Finally, for those concerned with anonymity, Gawronsky points out that Goldman and other large banks offer algorithmic trading. These are computer-based trading mechanisms that can be used to disguise movements — breaking up a large trade into smaller trades throughout the day, for example.
When all is said and done: “I’m not sure it will materially affect Goldman’s revenues,” Gawronsky says. “You could argue they don’t have that much to lose, and what do they gain? Potentially a PR win and something that customers may applaud.”
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