ATMonitor Commentary January 2012 Issue
The ins and outs of Dark Pools 8 things you wanted to know about Dark Pools but hesitated to ask
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The ins and outs of Dark Pools 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 may 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, MyATMonitor Expert Panel topics include 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.
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The ins and outs of Dark Pools ATMonitor Commentary
Experts Panellists: Charlie Guy Charlie Guy is part of the Chi-X Europe business development team. Charlie 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. Chi-X Europe offers trading in more than 1,300 of the most liquid securities across 25 indices and 15 major European markets, as well as ETFs (exchange traded funds), ETCs (exchange traded commodities) and IDRs (international depositary receipts) in both a visible order book and the Chi-Delta™ non-displayed order book. Chi-Delta now ranks among the largest publicly declared dark order books in Europe.
Salvador Rodriguez Salvador 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.
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.
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The ins and outs of Dark Pools ATMonitor Commentary
Experts Panellists: Jerry Avenell Jerry Avenell is part of the Chi-X Europe business development team. Jerry joined Chi-X Europe in November 2007 from the London Stock Exchange .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. Chi-X Europe offers trading in more than 1,300 of the most liquid securities across 25 indices and 15 major European markets, as well as ETFs (exchange traded funds), ETCs (exchange traded commodities) and IDRs (international depositary receipts) in both a visible order book and the Chi-Delta™ non-displayed order book. ChiDelta now ranks among the largest publicly declared dark order books in Europe.
Natan Tiefenbrun 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 last 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 singlestock, 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.
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The ins and outs of Dark Pools ATMonitor Commentary
Editor’s Choice: Selected Questions and Answers from the ‘Dark Pools’ expert panel.
How do independent dark pools determine who can be members? Charlie Guy, Chi-X Europe From a Chi-X perspective any trading participant may access the Dark Pool. We do however monitor behaviour in all of our books very closely and we would be sensitive to any activity which would be deemed to be against the spirit of the dark book. We have many anti-gaming monitors across both lit and dark books and actively intervene if we see any activity which we feel is contra to the best interest of the marketplace. Jerry Avenell, Chi-X Europe All Trading Participants of Chi-X Europe are eligible to access to Chi-Delta, our dark pool—there is no separate agreement, we route orders based on the values in certain FIX tags sent in the trading message. Natan Tiefenbrun, Turquoise LSE Group Similarly, all trading participants of Turquoise can access our Midpoint Order Book. In addition to sharing the surveillance approach outlined by Charlie, Turquoise also offers functionality that allows participants greater control over the type of liquidity with which they interact, and so we work with clients to help them use these features and to ascertain the improvements in execution quality they can bring.
Is there a level of distrust and obscure liquidity measures which make the use of dark pool dealing subject to best price irregularity? Salvador Rodriguez, Citi I don’t think ‘distrust’ is the right word to use. I think all orders that interact with any dark liquidity should be afforded some kind of protection. By that, I mean that users can choose to have minimum fill sizes, price limits and know that the vehicle chosen to transmit the order to the market (typically via a broker SOR), is employing some form of anti gaming logic to protect the order and the user. So the question one should reasonably ask of their brokers is ‘can I have a minimum trade size? What anti gaming measures do you use? Who do you allow into your pool? Who interacts with this liquidity?’ Each ‘venue’ also has its own rules regarding where to cross and with whom. Some cross at mid, others give the benefit of the spread, or most of it, to passive or resting flow. But the prices are always referenced from the primary market, so one can always monitor for quality of execution.
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The ins and outs of Dark Pools ATMonitor Commentary
Should I only send fill or kill orders to a dark pool? Charlie Guy, Chi-X Europe I would suggest not. We are encouraging members to leave orders resting as long as possible (maybe using a minimum tradeable quantity) in the dark book as we are seeing a number of missed opportunities. There is quite a lot of flow being moved around between venues as IOC or FOK orders—anyone who can ‘rest’ in the dark is going to meet this flow which in turn should attract further volume. A resting order could kickstart this virtuous circle which a fill or kill might miss. Natan Tiefenbrun, Turquoise LSE Group Some buy-side firms prefer to only use IOC/FOK in MTF dark pools because they don’t want to allow potential counterparties to choose the time (and hence price) of execution—they’re worried about being picked off. So there’s a perceived trade-off between fill-rate and execution quality. MAQ is one way to manage this concern, but Turquoise offers a second, unique, solution—an extra order flag allows participants to limit their interaction only to other patient resting orders by taking advantage of our random-timed periodic matches (from which IOC/FOK and short-lived resting orders don’t are largely excluded).
Which dark pools have liquidity dominated by HF Traders? Natan Tiefenbrun, Turquoise LSE Group In our experience, most ‘HF Traders’ are either market-making (in which case buying & selling at the midpoint is unattractive), or are predominately aggressive (in which case they’re typically in too much of a hurry to waste time checking non-display venues for liquidity). So non-display venues are definitely more attractive if they allow market-makers to capture the spread (just as they do in lit markets)—hence those MTFs/BCNs that support matching at/near the BBO are likely more attractive to them than those (such as Turquoise) which only offer Midpoint matching. Of course, some BCNs may deny HF Traders access, or may offer clients the choice of whether or not to interact with such liquidity.
Do all dark pools guarantee price improvement? Jerry Avenell, Chi-X Europe The Chi-X Europe non displayed order book, Chi-Delta operates under the reference price waiver which requires us to trade at mid of a recognised bid-offer spread—broadly speaking this is still the market of listing. So we offer price improvement of half the spread to our customers. The rules under which dark, (or non-displayed order books as we prefer to describe them), vary from venue to venue based on their regulatory approvals. Generally the broker pools operate under a different regulatory regime however one would to suppose that they all offer price improvement to a degree.
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The ins and outs of Dark Pools ATMonitor Commentary
Which is the most successful broker dark pool? Salvador Rodriguez, Citi Ultimately, you would have to define successful. Some would highlight a high $ traded number as being successful; others would highlight non toxicity and quality of fill/execution; others the composition of the pool (do they allow HFT/Stat Arb, do they onward route? If so, where?); some are stronger than others in the small/mid cap space and so on. There are numerous publicly available reports that try to answer the question you pose. It’s not always easy to assess, however, as not all brokers publish their dark pool numbers publicly. Citi is one of the group of brokers that do publish. Ultimately, end users (clients) will have the final say in whether a broker pool is successful or not as they will be the ones seeing their trades being executed and will therefore evaluate that broker and experience accordingly.
Was the much greater use of dark pools anticipated when MiFID was developed? Natan Tiefenbrun, Turquoise LSE Group MiFID effectively stopped exchanges and MTFs supporting fully hidden orders in their main books, requiring to create dedicated non-display order books (incidentally, this means that exchange/MTF lit books rarely offer “price improvement”, making them less attractive compared to other alternatives). So in relation to exchange/MTF pools, the increase was very much baked-in to the rules.
Do dark pools increase the likelihood of a ‘flash crash’ event in Europe? Natan Tiefenbrun, Turquoise LSE Group No. Reference price dark pools take their prices from lit markets, rather than by generating the execution price according to supply and demand within the pool. Accordingly, dark pool orders cannot influence prevailing market prices. A reduction in liquidity in lit markets is more likely to increase the chances of a flash crash—but there are factors more relevant than the use of dark pools to ensuring lit markets remain liquid. Jerry Avenell, Chi-X Europe No, the flash crash was caused in some part by the market structure in the US and in part due to the lack (or failure) of the brokers DMA limit checks when a mutual fund entered an un-priced order with no limits attached, and the subsequent unintendedreaction of other market participants electronic trading systems. One of the unintended consequences of Reg NMS in the US is that the trade through rule can cause a ripple effect across multiple market centres, which coupled with the lack of appropriate volatility halts in some market centres, resulted in the “perfect storm” scenario that occurred on May 7th.
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The ins and outs of Dark Pools ATMonitor Commentary
Dark pools (in Europe) operate under a number of different regulatory conditions which are dependent on who operates them. Chi-Delta, our non-displayed order book operates under the reference price waiver regime, where we execute trades based on the mid-point of a recognised / approved lit venue (currently this is the market of listing in each national market place). Broker pools operate under different regulatory regimes and I am sure one of the other panellists will be able to contribute here. In Europe all the National Exchanges operate volatility halts on their market at stock level, so the flash crash scenario would not be able to manifest in the same way. Ergo, if there is a volatility halt on the market of listing, trading in that security on Chi-Delta is suspended until continuous trading resumes so suffice to say therefore, a flash crash type scenario could not occur. Salvador Rodriguez, Citi Not likely because of the inherent market structure differences between the US market and markets in Europe.Europe has (and has had for a while) circuit breakers that put stocks into suspension if they move aggressively away from dynamic and static levels. This was lacking in the US at the time of the ‘flash crash’. In Europe, dark pools typically reference the primary exchange best bid and offer prices to establish a ‘prevailing market price’ for their dark pool.
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The ins and outs of Dark Pools ATMonitor Commentary
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