There seems to be an entrepreneurial spirit to this, however: find a regulated niche, weasel around it to provide clients with a high-growth and unsafe market. If the SEC doesn’t clamp down on this, I can see this sort of dark trading becoming popular enough to destabilize the economy once it fails.
Regulators can't regulate the demand away. They can only push it underground, beyond the light of day. Whether this is a desirable social outcome or not I leave as an exercise to the reader.
It's not clear to me why regulators want to prevent mutually agreeable transactions from taking place. Surely when GS is on the other side of the table, you are aware that you are swimming in the deep end with the big boys...
In general, because the regulatory functions are aware of information asymmetries that could lead to large numbers of people transferring a significant amount of wealth to smaller number of other people.
Wealth concentration is expensive for society, because those who lose out do NOT give up their right to vote replacement money into their pockets. The more of them there are, the more likely they are to get society to cover some of their losses.
I doubt this is the actual principle upheld. You have just described the role of insurance, as provided over the last 300 years or so, as something regulators want to prevent. You have asymmetrical information and a massive pool of people transferring premiums to a smaller group (the insurance companies themselves). Then, when there is a payout, you have the smaller group transferring massive amounts to yet smaller individuals (the ones who experienced catastrophic loss).
And "it's going to happen, so we should just let it happen" isn't a great justification for anything. "Regulators can't regulate robbery away." "Regulators can't regulate assault away." This doesn't mean that nothing should be done. I agree that regulation may not be the best answer, but throwing it all out is likely to be as bad or worse.
I have no beef with enforcing laws to prevent a priori harmful actions. By this I mean: actions in which we don't need to wait 10 years to decide who the victim is.
A more apt analogy would be the War On Drugs. Good luck attempting to regulate the demand away, when you have mutually agreeable transactions in which both sides believe they are benefiting.
The situation around an unregulated financial industry is much less clear. Without any regulation, I don't imagine that the world would be a better place. At least, it's not as clear to me as a world with legal drugs.
I believe the same things apply to mutually agreeable transactions. One of the main reasons subprime blew up is that the ratings agencies gave AAA ratings to the toxic CDS instruments. AIG and several other large institutional investors such as pension funds have regulatory requirements to only buy AAA-rated debt in various scenarios.
This promotes an environment of ignoring due diligence and relying on the ratings agencies operating on 3rd-rate employees and perverse incentives.
My broader point is that the public is clamoring for Big Daddy to regulate away the risk. We all want to make 15% per year, risk free. The reality is that risks are correlated with rewards, and there are a wide range of investment products to match individual needs.
What is the right amount of regulation? Beyond addressing information asymmetry or recognized market failures, I can't imagine much. Have the failures of the past 20 years been from too much regulation or not enough? How do you tell? How much is too much?