Nothing says ‘shady nefarious practice’ quite like a mysterious, gothic moniker. ‘Dark pools’ – off-exchange trading venues that don’t display quotations to the public – have attracted their fair share of bad press and regulatory attention of late, and it’s easy to imagine that at least some of the blame is attributable to the freewheeling techies who came up with the name.

In the late 1990s, when the term ‘dark pools’, or dark liquidity, first started cropping up, it probably sounded edgy and dynamic, but now – with the public eyeing the banking system with, at best, suspicion – that name is an additional burden the industry doesn’t need.

In October the US Securities and Exchange Commission (SEC) proposed a set of measures intended to increase the transparency (or “shed some light”, as those wags at the SEC put it) on dark pools, while in November the Financial Services Authority (FSA) finished collecting data from dark pool operators and banks on European dark pool volumes. The FSA’s data will feed into an EU review of dark-pool trading set to be completed by the end of the year by the Committee of European Securities Regulators (CESR); this will inform a comprehensive rethink of the Markets in Financial Instruments Directive (MiFID), which effectively opened the European market up for dark pools to exploit on its introduction in 2007.

Attention from the press has focused on the regulators’ post-crisis shakedown, and the fact that many of the dark pools are operated by major players – two of the largest are Goldman Sachs’ Sigma X and Credit Suisse’s Crossfinder – has added to the intrigue. And furthermore, the pools are expanding – share trading on European dark pools is approximately five times the value it was at the start of the year (from €2.2bn in January to €9.5bn in October, according to Thomson Reuters), though this figure represents only a fraction of the total share value traded (the figure varies, though US consultancy Tabb Group estimates 4.2 per cent).

For all the recent excitement, though, dark liquidity is nothing new: non-displayed trading is as old as floor trading itself. In a September 2009 report defending technological innovations, Goldman Sachs said dark pools were not a recent invention, but “a technological evolution of classic market structure”. The report also aimed to debunk a number of other myths: namely, that dark pools would create a two-tiered market; that they undermine price discovery; that they make up a large portion of trading activity; and that they fragment the market as well.

These myths, needless to say, appeared to draw heavily on proposals by the SEC, a rejuvenated organisation galvanised into relentless action in the wake of the financial crisis, and whose plans are “intended to prevent the development of a two-tiered market in access to pricing information, further promote displayed liquidity, and enhance transparency of trade information,” according to the regulator’s co-director of the division of trading and markets, James Brigagliano.

Where Goldman and many others agree with the SEC, however, is that something needs to be done about actionable indications of interest (IOIs) – similar to a buy or sell quote, but only conveyed to selected participants – and flash trading, in which stock exchanges allow larger clients to view orders before they’re published to the rest of the market.

The SEC’s proposals for dark pools include treating actionable IOIs in the same way as other exchange quotes, and therefore subject to the same rules and regulations for disclosure – a change also favoured by Goldman Sachs – while Flash orders will be banned in their entirety. The latter in particular could prove interesting. When Nasdaq and Bats withdrew their flash services in August, New Jersey-based Direct Edge was left as the only exchange with a flash order programme. Flash orders are said to represent a significant proportion of Direct Edge’s profitability.

The early part of 2010 promises to be an interesting time for dark liquidity in all its forms, with CESR set to complete its review of dark pools before the start of the year and the SEC planning to release a further review shortly afterwards, announcing in an ominously grave tone that “dark liquidity in all of its forms raises a variety of important policy issues that deserve serious consideration.”

But it’s hard not to feel that they, and the other regulators, have missed a trick. Perhaps what’s needed is not so much an overhaul as a rebranding. They can start by changing the name…

By Jon Hawkins