Regulators are moving to shine a light on “dark pools”, opaque and quasi-anonymous trading venues.

New York’s attorney general has filed a lawsuit against British bank Barclays relating to its dark pool, accusing it of giving an unfair edge to high-frequency traders while claiming to be protecting other clients from them.

What Is A Dark Pool?

Dark pools allow big blocks of shares to be traded anonymously without publicly informing the market until the trade is completed. This minimizes the risk of the price moving to the disadvantage of an investor should the market get wind of the trade before it is executed.

If a fund manager wants to buy shares of a given company, a dark pool will be able to match the order to sellers without publishing the price or order details beyond guidance that the price should be at the mid-point of a range.

On a public exchange, a trade could be costly for the buyer if the bourse’s publicly quoted data allow traders to spot the tell-tale signs of a big lump of stock being traded. In a world where trading is super-fast and electronic, the effect on the stock price could snowball.

The popularity of dark pools has grown over the past decade, alongside advances in automated trading technology, as new trading venues have sprung up to compete with the dominant bourses. A report by consultancy GreySpark Partners estimates that dark pools account for 12 percent of U.S. equity market flows. The figure for Europe is 10 percent and for Asia less than 3 percent.

So What’s The Problem?

Increasing competition in the exchange world over the past decade has led to the creation of many different versions of the dark-pool model, with varying shades of transparency and potential for market abuse.

Consultancy Oliver Wyman has identified three different types of dark pool: those run by traditional exchanges, those run by brokerages or banks and those run independently.

The exchange-sponsored pools offering equal investor access have also attracted the high-frequency traders that some investors preferred to avoid.

Some other pools, including those run by big banks such as Barclays, offered investors the option to avoid certain types of high-speed traders depending on their risk appetite.

The problem has become one of investor confidence and trust in a system that was initially designed to help investors.

“For investors, this is the equivalent of going surfing … When you’ve got panels saying ‘beware of the sharks’, you know you’ve got sharks,” said Frederic Ponzo, managing partner at consultancy GreySpark Partners. “It’s when there is no sign and you put your kids in the water that it’s a problem.”

What Are Regulators Doing About It?

U.S. regulators are pushing for more transparency on the part of dark-pool operators. Alternative trading systems now report volume data to the Financial Industry Regulatory Authority and more banks have begun publishing details of how their systems execute trades in the dark.

Some fines have been imposed. Pipeline Trading Systems paid $1 million in 2011 to settle allegations from the U.S. Securities and Exchange Commission that it was misleading investors by secretly allowing an affiliate to take advantage of access to its dark pool’s order flow.

Earlier this month dark-pool operator Liquidnet paid $2 million to settle SEC allegations that it had improperly used its subscribers’ confidential trading information to market its services. Liquidnet has since said it has tightened up its procedures.

In Europe, dark pools also face more oversight as part of a package of new rules known as “MIFID II”. Under the outlined plan, trading in a stock anonymously will be capped at 8 percent of the total amount traded of that stock in the European Union.

Dark trading in a stock on an individual platform would be restricted to no more than 4 percent of the total EU market for that stock.

(Reporting by Lionel Laurent; editing by David Stamp)