The Impact of Dark Pools on Access to Desirable Liquidity

Risk Mitigation Strategies
The list of blue-chip institutional clients using our dark aggregator in Asia demonstrates the quality of flow in dark pools in the region. However, like in any type of venue, there may be undesirable flow found as well – such as participants engaged in gaming, information seeking and other predatory behaviours – so it’s not advisable to interact indiscriminately with any and all dark liquidity. Furthermore, there is no obligation on behalf of pool operators to disclose the identities of their participants or even a foolproof method of determining which pool participants present risks to other clients. So rather than attempting to dictate the terms around the type of flow they interact with, we advise clients to use a multifaceted technological solution to increase the benefits and mitigate the risks.
First and foremost, clients should know where their broker is routing and why. This does not just apply to dark pools, but all venues. Best execution policies, where they exist in Asia, don’t specifically address venue access, so all routing decisions are made at the discretion of the broker. This means client interests can be compromised by a desire to internalize, substandard routing technology and venue pricing.
Also, some pools onward route to others, taking control away from the broker with whom the client has entrusted their order (for that reason, we have policies in place to ensure we do not access pools that onward route).
Next, we recommend using an aggregator that includes intelligent anti-gaming capabilities to manage your interaction with dark venues. Functionalities such as support for minimum fill sizes, randomisation, and analytics that evaluate short-term pricing models, volatility and spread changes before sending order slices are generally quite valuable.
It is also advisable to monitor results in real time. The FIX Protocol provides tags on both a live and post-trade basis that allow clients to view the dark pools in which their orders are being filled. So even if using a product that is aggregating over 20 dark pools, for example, clients are able to accurately evaluate the liquidity with which they are interacting on a real-time basis.
Finally, we urge clients to supplement this with post-trade analytics, which allow the risk versus benefit trade-off to be effectively weighed. A venue’s benefits can typically be accessed by analyzing standard trading performance metrics including fill size, price and frequency, while its risk can be measured by evaluating any changes in price, quote, volatility or a reversion to other prices during and after interactions.
Benefits and Costs
In our view, the benefits of dark pool trading far outweigh any additional costs. The real cost is that institutional traders must now be familiar with more sophisticated tools to access fragmented markets, but the benefits are that clients can access more liquidity, often with price improvement. For example, in a recent month clients in Asia using our dark aggregator executed an average of seven times more than the primary market’s consideration during their order’s trading interval. They also enjoyed an average spread capture of 49%, or about 10 bps versus what they would have paid to cross the spread. Slippage across market caps was -11 bps versus the arrival price and performance versus Interval VWAP and participation-weighted average price (PWAP) (20%) was +10 bps and + 3 bps respectively.¹
[1] Statistics from Instinet’s Insight trade analytics suite.