ATMonitor Commentary June 2011 Issue How to Catch a Black Cat in a Dark Pool or five things you wanted to know about Dark Pools but hesitated to ask www.atmonitor.co.uk How to Catch a Black Cat in a Dark Pool ATMonitor Commentary Foreword This is not an academic paper on theoretical discussions but rather a series of practical questions and answers that members of MyATMonitor have asked and industry experts answered. Our primary goal is to bring knowledge that will be useful to traders on the buy side. In fact, this philosophy is well reflected in the very heart of MyATMonitor, a reliable, independent and trusted peer-group network of and for buy-side only institutional traders. This publication has been compiled from ongoing Q&A activity on the MyATMonitor Expert Panels. At the time of publication, the Expert Panels on MyATMonitor are Dark Pools, Commission Sharing Arrangements, EMS/OMS Relationships, Fragmentation of Liquidity, MiFID II and Transaction Cost Analysis and Best Execution. The ATMonitor team would like to thank all members and experts that have generously contributed to the success of MyATMonitor. ATMonitor Team. www.atmonitor.co.uk 2 How to Catch a Black Cat in a Dark Pool ATMonitor Commentary Experts Panellists (in the order of appearance): Chris Jackson is head of EMEA Execution Sales at Citi. He is responsible for sales of the firm’s electronic trading and execution platform to European Institutional and Hedge Fund clients. He joined the firm in September 2009 from Merrill Lynch where he was latterly responsible for sales of the electronic, portfolio and transition trading product to European clients. Prior to taking that role, Chris spent three years with Merrill Lynch in New York where he was responsible for sales of the international portfolio trading business. Chris joined Merrill Lynch London in 1997 having started his career at SBC Warburg. In addition to his role at Citi, Chris is also co-Chair of the FIX committee in Europe. Natan Tiefenbrun joined LSEG in 2009 to develop a pan-European dark pool, and became commercial director of Turquoise following LSEG’s acquisition of a majority stake earlier this year. At Turquoise he is responsible for product development, sales and marketing. Prior to that, he spent 13 years at Instinet, a pioneer of electronic trading, latterly as President of the Asian & European businesses. Over the years he was responsible for the conception & delivery of Instinet’s global EMS platform for single-stock, portfolio & algorithmic trading, the after-hours crossing network, transaction cost analytics, and for servicing the needs of quantitative investors from indexers through to high frequency traders. Sal Rodriguez joined Citi’s London Electronic Trading Team in November 2010. He is head of EMEA electronic sales trading with responsibility for managing the team of sales traders that manage electronic flow from the firm’s Institutional, Hedge Fund and Wholesale clients. Prior to joining Citi, Sal spent time with UBS and Goldman Sachs in London as an electronic sales trader. He started his career at Morgan Stanley in London where he spent 10 years as a pan European cash sales trader. Charlie Guy is part of the Chi-X Europe business development team. He joined Chi-X Europe in May 2008 from the Royal Bank of Scotland. Chi-X Europe is the largest European equity exchange by number of trades and the 2nd largest by value traded, according to the Federation of European Securities Exchanges. Disclaimer: The content of this report is provided for informational purposes only and has been obtained from sources believed to be reliable, but it is not necessarily complete and its accuracy cannot be guaranteed. It is not intended as an offer or solicitation for the purchase or sale of any financial instrument or as an official confirmation of any transaction. Moreover, this material should not be construed to contain any recommendation regarding, or opinion concerning, any security. Any views expressed in this report are those of the individual experts and do not necessarily represent the official view of ATMonitor or participating organisations. www.atmonitor.co.uk 3 How to Catch a Black Cat in a Dark Pool ATMonitor Commentary Editor’s Choice: Selected Questions and Answers from ‘Dark Pools’ expert panel. Which dark pools are most effective in generating larger sizes of executions? Chris Jackson, Citi All dark pools are capable of delivering large size executions. We’ve found however, that block orders will tend to reside more in dark venues that have a reputation for lower toxicity—consequently, knowledge of the large order is less likely to leak into the market. In our experience, dark pools that can place restrictions over the type of counterparts allowed to interact with the pool are likely to be less toxic and so attract larger blocks. Unlike MTF dark pools, Broker Dealer pools are able to restrict access in this way—consequently, a Broker dark pool will often attract larger blocks. At Citi, we strictly control the nature and type of counterparties that we allow to access the pool giving us a very low level of toxicity.The average resting order size we see in our dark pool Citi Match is in excess of $230k (April, 2011). Natan Tiefenbrun, Turquoise LSE Group Several factors determine trade sizes achieved by different dark pools: 1. Periodicity/Frequency of matching—dark pools that aggregate liquidity at a point in time tend to result in larger trades than continuous matching models. 2. Proximity to the “parent order”—dark pools in which the buy-side participate directly tend to result in larger trades than those which receive their order flow from the algorithmic/smart-routing infrastructure of brokers. 3. Whether orders must be firm—dark pools which allow non-firm orders (e.g. they will not match without a further confirmation from the owner) can receive larger orders (since the same order can be simultaneously represented elsewhere). What is ‘toxic’ liquidity in dark pools? Natan Tiefenbrun, Turquoise LSE Group Brokers often evaluate dark pool executions based upon whether the trade price looks attractive 3-30 seconds after the fact. If trades in dark pools subsequently look unattractive, then perhaps they would have been better not participating in that pool. By comparing the results from different dark pools, brokers can identify those in which they are more susceptible to gaming or adverse selection. Turquoise works with brokers to help them measure these effects, to understand their causes, and to mitigate them. Chris Jackson, Citi A trade in a dark pool against a toxic source of liquidity would tend to result in price action against you—the toxic counterparty you have traded against would tend not to have natural inventory but to opportunistically post orders in the pool (often both buying and selling) in order to find out or “fish” for genuine order flow. Once a genuine order is identified, the counterparty may use a number of aggressive www.atmonitor.co.uk 4 How to Catch a Black Cat in a Dark Pool ATMonitor Commentary strategies that seek to take advantage of knowledge of the order. Dark pool providers may turn a blind eye to toxic or predatory liquidity since it creates the appearance of additional liquidity in the pool whilst any negative price impact may be more difficult to identify. Dark MTFs cannot exclude a counterparty just because it may be perceived to be toxic, Broker dark pools can (if they choose to measure it). Citi assesses the toxicity of counterparts and seeks to exclude toxic ones. How do I know my orders are anonymous when in a dark pool? Natan Tiefenbrun, Turquoise LSE Group By ‘anonymous’, I presume the question is both “how do I know my order cannot be seen by anyone?” and “how can I be sure that nobody knows my firm is active in a given stock?” In respect of MTF dark pools, the FSA insists on strict segregation of data. At Turquoise, for example, the commercial oriented staff cannot see the details of any open orders in the Midpoint Order Book. Whilst BCNs might not be subject to the same rules, brokers surely cannot afford the reputational damage that would result from allegations of information leakage. And enough staff move between brokers to ensure that any unethical practices would soon be outed. So I would suggest that, if you’re dealing with a reputable firm, whether MTF or BCN, you should assume your orders are indeed dark and your trading anonymous. Salvador Rodriguez, Citi Protecting the client and their order is something all good Dark Pools should offer as standard. There are various mechanisms that brokers employ to ensure that this is the case. At Citi, we naturally take this very seriously as we will do everything we can to protect our client franchise. Consequently, we have geographical and technological segregation from other business areas to prevent any form of anonymity being breached internally.We employ stringent anti gaming logic that protects the order once it is received. We also restrict access to CitiMatch which means we have the ability to control and reduce potential toxicity. We have total control of who is actually allowed into our pool. Nor will we advertise any order we may have in CitiMatch. We therefore also protect from breaching anonymity externally. It’s easy to measure. Any post trade analysis will show you whether or not there has been any leakage by looking at the reversion numbers for that order. It is also easy to measure real time by looking at your execution price and comparing it to the prevailing market price. Why do some algorithms seem to get more fills in dark pools than others? Chris Jackson, Citi A lot of factors at work here: 1) Liquidity profile in dark pool—some dark pools will have high pass-through volumes (small orders on way to market), others will have more resting block liquidity. 2) Trading objective of algorithm—different algos look for liquidity in different ways—a VWAP algo will be www.atmonitor.co.uk 5 How to Catch a Black Cat in a Dark Pool ATMonitor Commentary less likely to take a block than an aggressive algo as it will introduce deviation and therefore performance risk relative to the specified benchmark. Implementation Shortfall and aggressive algos will. 3) The Citi algorithms interact with dark liquidity with varying levels of aggression depending on the trading objective—algorithms on passive settings will tend to rest passively in the pool maximising spread capture—often capturing 80-100% of the spread. Aggressive algorithms like Dagger 4/5 will potentially cross the spread in the pool to capture more liquidity. Natan Tiefenbrun, Turquoise LSE Group Agreed—it’s all about the algo’s strategy, the number of pools it accesses, and what parameters the algo applies to orders. A more passive or block-oriented algo strategy might apply a higher MAQ (minimum acceptable quantity) to orders, which would avoid small fills at expense of reducing the match rate. Similarly, it’s possible in the Turquoise Midpoint Book to opt out of interacting with orders demanding immediacy (e.g. IOC), thus restricting interaction to other ‘patient’ participants—you might use this to be even more ‘passive’ in your strategy, but any decision to constrain matching (whether limit price, MAQ or IOC optout) will reduce the fill rate. Are independent dark pools viable in competition with broker dark pools? Charlie Guy, Chi-X Europe Can I assume that by independent dark pools, you are referring to the pools such as those run by the MTFs? If so, it is interesting that you ask if those pools are viable in competition with broker dark pools and not the other way around since it is the MTF pools which are the larger. I think the two types of pools offer different results and are going to draw in clients for different reasons. Fills are likely to be larger with a broker orientated pool and it may also offer an outlet to fulfil commitment to a broker. However these pools are not always open to as large an audience as the independent pools, so brokers offering dark algos which need to sweep as much resting liquidity as possible are more likely to be drawn to the MTFs. We are already seeing concentration in the number of available ‘lit’ trading venues and it’s not hard to imagine there will be similiar consolidation in the dark pools. However I do think there is scope for pools to further differentiate on the size of trade they generate, ie minimum or no minimum size. Whether this plays into the hands of the independents or brokers remains to be seen, but overall I think the readily open access models of the independents is a strong plus point in their favour (but, of course, I am biased!). Salvador Rodriguez, Citi Each dark pool has its own trading characteristics. Broker pools differ from one another in the way they interact and trade with liquidity. Each one is different. Some connect to external pools for example, others do not. Independent dark pools can succeed, however. Their success will be measured on how much liquidity they have, the quality of the execution as measured against prevailing market prices and any reversion associated with particular fills. One can also measure size of execution. Are fills only of 1 share lots? Or are they more meaningful in size? www.atmonitor.co.uk 6 How to Catch a Black Cat in a Dark Pool ATMonitor Commentary Another question users of dark pools should be asking is how that particular venue is protecting an order. • What anti gaming measures are in place? Who has access to and the ability to interact with that Pool? Do they advertise to the market the composition of the pool real time? • Brokers generally have the benefit of interacting with many streams of in house flow: PT, Cash and so on. It is less clear how and with whom independent pools are interacting, which makes knowing the answers to the above very important. • At Citi, we strictly control the nature and type of counterparties that we allow to access the pool giving us a very low level of toxicity. Natan Tiefenbrun, Turquoise LSE Group It’s an interesting question, and it has generated some interesting answers! Independent dark pools certainly figure more prominently in the European landscape than they do in the US. Broker-pools (and their clients) enjoy some advantages that MTF pools do not—including the right to control admittance (more talked about than used), to trade anywhere within the spread, and to offer some optionality about which categories of customer interact. Broker pools are also closer to the buyside and hence to the larger ‘parent order’. On the other hand, there’s some disagreement about what type of access can be provided and to whom, with some regulators pushing to limit broker pools to direct matching between buyside clients—a restriction that would substantially alter the liquidity profile of many pools. Whilst MTFs have to be non-discriminatory in terms of access and matching, they can of course appeal to a wider audience. The need to tackle ‘toxicity’ which Salvador highlights is a real issue—and one which Turquoise has a unique approach to—allowing customers to opt-out of interacting with immediacy-demanding flow. I expect that a lot will depend on whether public/neutral pools are every broker’s second destination, or whether linkages between broker dark pools ultimately reduce public venues to being “destinations of last resort”. The outcome will likely depend on the contents of MiFID II. In the meantime, we’re working on enhancements to our dark pool to make it more attractive for institutional block traders. www.atmonitor.co.uk 7 How to Catch a Black Cat in a Dark Pool ATMonitor Commentary About ATMonitor ATMonitor is a new service designed to offer buy-side traders a unique, valuable and independent resource in the field of global equity trading and technology. Its member-only part, MyATMonitor is a service available only to buy-side traders and provides a unique environment where members can share knowledge and experience directly with each other, through forums and blogs, confident that service suppliers, consultants, headhunters etc. are excluded from the dialogue. This exchange is encouraged through opinions, editorial, research and analysis, provided by experienced personnel with close knowledge of the global equity trading business. Visit us today at www.atmonitor.co.uk To discuss any part of this report, contact: Jason Murray [email protected] +44 (0) 208 466 5650 +44 (0) 7817 901 757 Rufat Khamidov [email protected] +44 (0) 208 466 5650 +44 (0) 7424 364 511 For marketing, membership and other business enquiries, contact: Karen Delahoy [email protected] +44 (0) 208 466 5650 +44 (0) 7793 884 244 www.atmonitor.co.uk 8
© Copyright 2024