The "shadow market" is a broad-based moniker with both positive and negative connotations. It can refer to: the confluence of power between wealthy individuals and sovereign nations, housed in secret jurisdictions and sovereign wealth; dark pools to promote more effective trading; the black market for goods and services, where items can be had on the cheap for anyone willing to pay with much-needed hard currency; and shadow banking, financial intermediaries that are not banks. Here is a basic discussion of each.

Littoral Jurisdictions
Offshore is onshore is offshore. Any region in which an individual does not make as his or her primary residence is considered offshore. The notion of offshore as a distant subequatorial venue, typically an island, is only partially true. Ireland, the United Kingdom and the United States are offshore jurisdictions, as are places such as Jersey and the Cayman Islands. These locations afford individuals and corporations tax havens that enable them to skirt rules and regulations of the jurisdiction where they are domiciled.

While corporations may claim avoidance of double taxation as a legitimate claim to use these jurisdictions, governments could accomplish the same result through tax treaties, yet fail to do so, precisely because the havens themselves do. The result is that corporations often end up paying little, if any, tax. Tax avoidance such as this on a grand scale is considered free riding, as it often deprives the local economy of tax revenue needed to pay for infrastructure, education and other endeavors for the public good. Additionally, tax havens provide potential escape routes for despots looking to hide ill-gotten gains, beyond the reach of law enforcement.

Governmental Brokerage Accounts
A sovereign wealth fund is, effectively, a government-managed investment portfolio funded by foreign exchange reserves earned through exports, or other sources of revenue, and invested in accordance with stated objectives. Seers have looked at such vehicles with approval and suspicion alike: with approval when they acted as saviors to some of the banks brought down by the 2007-2008 financial crisis; and with suspicion when they make large investments in companies with what would appear to be veiled attempts at political influence or market manipulation.

Behavior of these funds is watched closely, given the enormity of the assets they control. Such concerns prompted the formation of the Generally Accepted Principles and Practices (GAPP), also known as the Santiago Principles. These call for clearly-stated objectives, rules of operation, transparency and acting in the fund's best interests. Compliance is voluntary, however, and some funds have adhered to these principles with greater rigor than others.

SEE: An Introduction To Sovereign Wealth Funds

Dark Pools
Dark pools are relatively new alternative trading systems, designed to preserve anonymity and liquidity, provide lower execution costs and minimize market impact. They are most applicable for odd-type orders (e.g., oversized, small and block orders, and illiquid securities), accommodating trading needs outside of conventional systems. Private contract law, rather than stock exchange law, governs transactions in this space. Different types of pools exist to accommodate different types of market participants.

Black Market
A black market in goods and services exists when purchasers and sellers exchange them at a rate that is at significant variance from the normal marketplace. During the Cold War, Eastern Bloc (Warsaw Pact) countries' currencies were soft, i.e., not readily exchangeable at market rates the way that Western governments' were. Starved for hard currency, merchants would exchange a quantity of Hungarian forints or Polish zlotys for far greater amounts of dollars or pounds, based on the economic fundamentals policy decisions driving the hard currency markets.

SEE: Getting Started - What Moves A Currency?

Non-Bank Financial Institutions
Coined by former PIMCO managing director Paul McCulley, the phrase "shadow banking" refers to the body of financial institutions that operate outside of the traditional, regulated banking system. These include non-bank mortgage lenders, money market funds, hedge funds, independent broker-dealers and structured investment vehicles (SIVs or conduits) that invested in illiquid mortgage derivatives, such as Collateralized Debt Obligations (CDOs).

Prior to the 2007-2009 financial crisis, none of these enjoyed safety nets such as lender of last resort (LOLR, read: central bank) or federal deposit insurance. The opacity of their funding sources, abetted by the rating agencies, gave a false impression of their creditworthiness, the true state of which was revealed during the market collapse of 2008.

SEE: The Fall Of The Market In The Fall Of 2008

The Bottom Line
"Shadow," "dark" and "black" all typically connote activities outside of conventional channels. One should take care not to paint all such activities in a negative light. Shadow banking activities are not illegal, but providers' and users' expectations of the economic environment occasioned greater reliance upon them, until many of them unwound with disastrous consequences. Sovereign wealth funds' activities often take place in the public realm and for legitimate purpose. With their size comes economic power on which policymakers need to remain focused for any unwarranted forays into industries and currencies where national interests and national security could be jeopardized. Finally, dark pools afford the potential for more efficient and cost-effective trading. By contrast, some activities, such as secret jurisdictions and black markets, have few positive attributes.

Related Articles
  1. Investing Basics

    10 Habits Of Successful Real Estate Investors

    Enjoying long-term success in real estate investing requires certain habits. Here are 10 that effective real estate investors share.
  2. Investing Basics

    5 Types of REITs And How To Invest In Them

    Real estate investment trusts are historically one of the best-performing asset classes around. There are many types of REITs available.
  3. Investing Basics

    5 Simple Ways To Invest In Real Estate

    There are many ways to invest in real estate. Here are five of the most popular.
  4. Stock Analysis

    6 Risks International Stocks Face in 2016

    Learn about risk factors that can influence your investment in foreign stocks and funds, and what regions are more at-risk than others.
  5. Investing

    3 Things About International Investing and Currency

    As world monetary policy continues to diverge rocking bottom on interest rates while the Fed raises them, expect currencies to continue their bumpy ride.
  6. Investing News

    Tufts Economists: TPP Will Reduce U.S. GDP

    According to economists at Tufts University, the TPP agreement will destroy half a million jobs in the U.S. by 2025.
  7. Retirement

    Dollar Shave Club Review: Is It Worth It?

    Learn about the business model of the Dollar Shave Club, and find out whether the razor subscription company is a worthwhile investment.
  8. Economics

    Governments Ask Tech Giants to Join War on ISIS

    In the US and Israel, governments have asked their respective nations' tech industries to help in the war against ISIS.
  9. Term

    The Implications of Nonfarm Payroll

    The nonfarm payroll is a key economic indicator that’s closely monitored by analysts and investors around the world.
  10. Investing Basics

    Understanding Real Estate

    Real estate is an encompassing term that refers to land, the buildings on that land, and its natural resources, such as crops and minerals.
RELATED FAQS
  1. What is a derivative?

    A derivative is a contract between two or more parties whose value is based on an agreed-upon underlying financial asset, ... Read Full Answer >>
  2. What is securitization?

    Securitization is the process of taking an illiquid asset, or group of assets, and through financial engineering, transforming ... Read Full Answer >>
  3. Can hedge funds trade penny stocks?

    Hedge funds can trade penny stocks. In fact, hedge funds can trade in just about any type of security, including medium- ... Read Full Answer >>
  4. How do mutual funds work in India?

    Mutual funds in India work in much the same way as mutual funds in the United States. Like their American counterparts, Indian ... Read Full Answer >>
  5. Can hedge funds outperform the market?

    Generating returns that exceed those provided by the broader market is the goal of nearly every investor. However, the methods ... Read Full Answer >>
  6. Where do penny stocks trade?

    Generally, penny stocks are traded through the use of the Over the Counter Bulletin Board (OTCBB) and through pink sheets. ... Read Full Answer >>
Hot Definitions
  1. Flight To Quality

    The action of investors moving their capital away from riskier investments to the safest possible investment vehicles. This ...
  2. Discouraged Worker

    A person who is eligible for employment and is able to work, but is currently unemployed and has not attempted to find employment ...
  3. Ponzimonium

    After Bernard Madoff's $65 billion Ponzi scheme was revealed, many new (smaller-scale) Ponzi schemers became exposed. Ponzimonium ...
  4. Quarterly Earnings Report

    A quarterly filing made by public companies to report their performance. Included in earnings reports are items such as net ...
  5. Dark Pool Liquidity

    The trading volume created by institutional orders that are unavailable to the public. The bulk of dark pool liquidity is ...
Trading Center