June 26th, 2014
By Rowan Bosworth-DaviesOne of the over-riding principles of free and well-regulated markets is that everyone who seeks access to trade must be permitted equal rights to knowledge of the prices being quoted, whether “buy” or “sell”. Anything less, and the market becomes a private playground for insiders who seek to benefit from the ignorance of the rest.
Market professionals have always sought to find ways to rig markets in their favour, which is why regulators reserve draconian penalties for those who seek to profit in such a way.
When a player seeks to buy or sell a particularly large holding of securities (or futures or options contracts, for that matter), the mere fact of that volume of shares being brought to the market has an immediate and dramatic effect on the prices being offered, which is not always in the best interests of the seller. This, however, is the nature of free markets, and it helps to maintain price and volume equilibrium.
In the past, investors who wanted to process a big trade would break it up into a number of smaller transactions – but algorithmic traders found ways of using computers to spot these trading patterns and prices were effected as they moved in to arbitrage the dealing.
Most recently, we have seen the emergence of ‘dark pools’, off-exchange facilities owned and operated by a small number of institutions to enable their clients to avoid these unfortunate effects of free-market capitalism.
A report in the Guardian describes how a number of banks in the US and Europe created these pseudo exchanges in order to carry out transactions on behalf of big clients who want to conduct huge buy or sell deals “behind the curtain” and without the price moving as the deal was done. The term “dark pool” was coined to sum up the opaque nature of these privately run platforms, which have become one of the main devices banks use to match buyers and sellers away from the main exchanges.
They are computer-driven, and cheaper than sending buy and sell orders through the US’s 13 public exchanges. Around 45 dark pools are in operation. The biggest are understood to be run by JP Morgan, Morgan Stanley and Credit Suisse.
The trades tend to be large positions of shares that would immediately attract the attention of other large shareholders, either encouraging them to sell their shares or persuading them to trade up. A dark pool transaction means that they only report price information after a trade has occurred.
According to Reuters, dark pools now account for up to 40% of shares traded in the US, up from around 16% six years ago.
The Guardian reports that Barclays bank now stands accused of ushering in the high-frequency traders to its secretive LX Liquidity Cross alternative trading system and letting them run riot. Or more precisely, let them bid on trades with clients without their knowledge.
As part of a law suit against Barclays, the New York attorney general, Eric Schneiderman, said Barclays duped customers who chose to trade in its dark pool into thinking they would be protected from these “predatory traders”, which use their speed advantage – processing trades through superfast fibre-optic cables – to deprive other investors of profits on every trade. The bank courted high-frequency traders in part by charging them virtually nothing, Schneiderman claimed.
He said: “The facts alleged in our complaint show that Barclays demonstrated a disturbing disregard for its investors in a systematic pattern of fraud and deceit.”
“Barclays grew its dark pool by telling investors they were diving into safe waters. According to the lawsuit, Barclays’ dark pool was full of predators – there at Barclays’ invitation,” he said.
The complaint details “a flagrant pattern of fraud, deception and dishonesty with Barclays clients and the investing public,” he added.
Like the Scorpion, Barclays simply cannot prevent itself from stinging its clients in false and deceitful ways. Financial criminality is deeply embedded in its corporate DNA.
Here is the Bloomberg Television item on the significance of this law suit for Barclays, where the BNP Paribas settlement is also mentioned. Announcing the lawsuit against Barclays, New York Attorney General Eric Schneiderman said the bank marketed “safeguards” to reassure users of its “dark pool” that they would be shielded from “predatory”, “toxic”, “aggressive” high-frequency traders.