The U.S. Securities and Exchange Commission will propose toughening its limits on the amount of anonymous trading carried out on stock platforms called dark pools, according to two people familiar with the deliberations ... The rule change may curtail the number of transactions on dark pools, off-exchange platforms run by firms such as Goldman Sachs Group Inc. and Getco LLC that have drawn scrutiny from Democratic Senators Ted Kaufman of Delaware and Charles Schumer of New York. The systems usually shut down trading in a security when they approach the current 5 percent limit. "If you were to limit the dark pools to that small amount of trading, it will be much harder to find a counterparty," said Dirk Hoffmann-Becking, a London-based analyst for Sanford C. Bernstein & Co. For stock exchanges, "if they would see less competition from the dark pool world, that would certainly be a positive for them." Investors use dark pools to execute bigger orders and avoid revealing details such as price and size that could move a stock, according to Sang Lee, a market analyst at Aite. The growth is hurting traditional markets, which face more regulation, the World Federation of Exchanges said in a letter last month to Mario Draghi, chairman of the financial-stability board of the Basel-based Bank for International Settlements. "The more the dark pools exist without any comprehensive regulation, the more you're going to see liquidity siphon off from exchange markets," Chicago Board Options Exchange Chief Executive Officer and WFE Chairman William Brodsky (pictured left with former SEC Chairman, Christopher Cox) said at a conference in Vancouver on Oct. 7. - Bloomberg
Dominant Social Theme: Sunshine is a necessary disinfectant?
Free-Market Analysis: The key here is the point being made by Brodsky - "without any comprehensive regulation, you're going to see liquidity siphon off from exchange markets."
We can see, with this phrase, how far the Western world has traveled from even timid assumptions that markets ought to be free and untrammeled -- able to respond properly, via supply and demand, to consumer preference.
Brodsky's world-view is much different - and it is shared by many if not most within the financial services industry. The view is that regulation, necessary or not, needs to be expanded so those who already operate with regulation are not put at a competitive disadvantage.
Let's unpack that a little. If regulation were such a necessary part of the marketplace one would think that those entities that were well regulated would have a competitive ADVANTAGE. In fact, we hear that all the time - that consumers flock to industry that is well-regulated by the state, and seek out such reassurance.
Why then is Brodsky so concerned about these so-called black pools of liquidity where buyers and sellers meet without regulatory supervision? It makes no sense within the context of the argument that regulation is not only necessary to the appropriate functioning of markets but also that markets that lack regulation are off-putting to participants and will not succeed in the long run.
Brodsky's fears within this context seem unnecessary. Let dark pools of capital continue without regulation and eventually they will wither and die - regulation being of paramount necessity.
In fact (sarcasm off), regulation is NOT sought out by most market participants, and Brodsky inadvertently has blurted the truth here: Those markets that are highly regulated are not nearly so attractive to participants as those markets that have little or no regulation.
There are other points to make about regulation, especially financial regulation. Chief among them is that regulation rationalizes and simplifies order flow - as the regulatory mind cannot easily encompass innovative complexity - which actually makes markets more vulnerable. The simplifying that takes place in regulated markets reduces or eliminates the strategic richness that makes instruments otherwise more resistant to panics and meltdowns. Ironically, regulated markets are even more fragile that unregulated ones in our opinion.
Conclusion: Markets crashed in 1929, kicking off the modern regulatory world of the 20th and now 21st century. In 1929, markets began to be rationalized and regulated so that the problems that then occurred would not occur again. Here it is in 2009, and these problems, after a century of regulation, have reoccurred with increased violence and now threaten the entire fabric of market capitalism. Yet more regulation is on the way.
Insanity: doing the same thing over and over again and expecting different results. - Albert Einstein, (attributed)
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