Best Execution in Dark Pools
Dark pools can be vital sources of liquidity for buy-side firms, but to achieve best execution in broker dark pools, asset managers must ensure that they understand the pool’s characteristics and have the right feedback in place to monitor routing. With end investors demanding greater levels of transparency, best execution requires process and diligence. (See our Opinion Poll results)
Jonathan Brunello and Kim Man Li of Bank of America Merrill Lynch’s Asia Pacific global execution services team answer the hard questions.
Q: How do you talk to clients about dark pools in Asia?Kim: We try to educate clients as to which alternative liquidity venues they should interact with and how. Our experience with our pool, INSTINCT X, has been favourable in that there are more advantages than disadvantages when interacting with all of the different available liquidity. We advise clients to connect to as many of the venues as possible and use that as an opportunity to understand the depth/breadth of liquidity that is on offer at each venue, how it is made up and to quantify how it benefits them.
Q: What are the advantages of trading in dark pools?
Kim: It is easier to execute off-exchange without impacting the price. The anonymity and liquidity that can exist in a dark pool are the primary drivers. That said, Asia is slightly different to other regions. All trades on dark pools here still get printed in real time on the exchange. So while the matching process is handled off-exchange it is not quite as invisible or dark as it could be in the US and Europe.
Q: As a client, how will you be sure where your order was executed?Jonathan: Fix Protocol Limited (FPL) did everyone a huge favour by making the execution destination available via FIX tags. It is incumbent on the sell-side to push the FIX tags back to client vendor systems, and on the client base to demand them from their vendors. If clients do not demand it, brokers don’t provide it, and vendors do not support it, there is a risk that orders are being routed and onwards routed to venues of which the client is not aware.
Q: How is transaction cost analysis (TCA) evolving with execution in dark pools?
Jonathan: TCA is moving beyond the measurement of execution performance versus benchmark or benchmarks. It is now at a point where clients are working with their execution partners to understand the factors that contribute to outperformance/underperformance versus a benchmark. More recently, we see a greater focus upon non-lit venue execution, and how this positively or negatively contributes to an execution outcome.
Q: Where should clients expect technology to help, when it comes to dark pools?
Jonathan: Everywhere really, be it their EMS providing real time data to the trader, their TCA partner helping shine the light on areas of focus, or their sell side partners continually investing in SOR technology. Technology cuts across everything we do that benefits our clients, especially in terms of access, execution and risk mitigation.
Kim: Some technology work is embedded in the pool itself. Anti-gaming logic is important; a pool does not have to cross. If the logic in the pool believes that the price is a fair price then its anti-gaming logic should hold true. It should have the ability technology wise to limit executions of a certain size with minimum cross limits. The pool should understand what is or is not a fair price depending upon movements.
Q: What is best practice for achieving best execution in dark pools?
Jonathan: It is really an extension of what the buy side and sell side already do. Firstly, both buy side and sell side should have real time transparency of where orders are being executed. Second, would be instilling a discipline of periodic post-trade execution analysis identifying multi period trends like excessive fill rates in dark pools, or sub optimal executions in dark pools based upon order momentum. Finally, ongoing collaboration between the buy side and the sell side on optimising execution performance is critical. We find that an increasing amount of our time is spent in this space — the client feedback loop is critical to ongoing development of our product.
When one thinks of best execution in dark pools, it is essential to look at factors beyond those offered within a standard post trade analytic report. Selecting an optimal execution strategy, understanding how each strategy interacts with the various execution venues, and what sources of liquidity make up the venues, are key to not only unlocking the value of dark pools, but also avoiding the potential hazards which exist.