U.S. Exchanges Benefit As Regulators Focus on Dark Pool Trading

Dark pools are electronic platforms designed for financial institutions and large banks to carry out major stock trades anonymously. In December 2010, dark pool trading accounted for nearly a third of total U.S. stock trades compared with about 17% in 2008.((‘Dark Pools’ Pick Up Stock-Trading Share, Jan 4, 2011, WSJ)) U.S. stock exchanges such as NYSE Euronext (NYSE:NYX), Nasdaq OMX (NASDAQ:NDAQ) and BATS Global have called for changes to the market regulations that would apply limits to dark pool trading as they worry if much of the trading is done privately, publicly available prices set by exchanges will become less accurate. The Securities and Exchange Commission (SEC) is now focusing on private stock markets which run dark pool trade, seeking a better view into the business done at such markets. ^[1]

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Dark pools were originally set up by asset managers at big banks and financial institutions to carry out large chunks of stock trades anonymously, without providing a chance to rivals who could bid up the prices of shares being bought or sell them lower. Dark pool trading also helps institutions in accumulating shares in a relatively thinly traded stock. Since private venues are seen as a more efficient way for transacting large chunks of shares, dark pool trading has increased significantly over the last couple of years.

But regulators are concerned about the level of disclosure in these markets. Potential rules that would require dark pools to offer better transparency into their business are under consideration by the SEC. This provides a window of opportunity for traditional stock exchanges such as NYSE Euronext and Nasdaq OMX to pull business back to their markets.

In a scenarios where regulations shifted half of the dark pool trading volume back to the stock exchanges, U.S. cash trading volume at these exchanges will increase by about 25%, which would represent about 5% upside to our price estimate for Nasdaq.

We have a price estimate of $27.59 for Nasdaq OMX’s stock, nearly 10% above its current market price.

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1. UPDATE: Nasdaq OMX: US Regulators Focused On Dark-Pool Trading, March 5, 2012, WSJ [↩]