Although liquidity aggregation is rapidly moving up the buy-side agenda in Asia, brokers continue to take a cautious and selective approach towards the sharing of dark pool liquidity with other providers.
“Discussions have been going on for a few years in Asia and none of the large brokers have been able to come to an agreement [on the way to connect their dark pools],” said Greg Lee, head of autobahn Equity, Asia at Deutsche Bank. “There was always fear of the unknown, fear of having a certain type of flow that may be detrimental to the other brokers' agency order and client base. So there was always some hesitance to make these agreements.”
Deutsche Bank launched its dark pool, known as Deutsche Bank Automated Trading System (DB ATS), in Hong Kong in August 2010, and plans to extend it to Australia, Japan and Singapore. DB ATS was launched concurrently with the bank's dark liquidity-seeking algorithm, SuperX, which had been available in the US and Europe since 24 March 2010.
Deutsche Bank's own guidelines on liquidity-sharing agreements with other brokers specify mid-point crossings and passive liquidity exclusively. “We believe that makes it fair for all parties. Some people will allow dark pools to connect on the bid or the offer and different price increments,” he said, “but we will only allow mid-point crossing in our dark pool and we apply the same rule when we connect to other dark pools.”
Lee stressed that only passive liquidity, and not fast-flowing DMA flow, is allowed in DB ATS. “We're doing this to help the buy-side source and aggregate liquidity and we believe that's a fair manner for all the participants. Everyone has some nuance which is slightly different. We're very strict about the anonymity of the flow. If we connect to someone and we find their flow is toxic and negatively impacting our clients, we'll do one of two things: the logic in the algorithm will change the ranking of that dark pool; and we'll be much more cautious about the type of flow that we put in there. In the extreme case, if we believe the sort of orders we're getting sent from that broker is detrimental, we will cut them off.”
Despite the caution of some brokers, liquidity aggregation is picking up in Asia. Instinet, for example, released its Nighthawk aggregation algorithm in Asia last year and the agency broker expects to access 14 dark pools across Asia by the end of the first quarter of 2011. Instinet has announced a number of liquidity-sharing agreements that provide its clients with access to TORA Crosspoint, ITG's POSIT, Nomura's NX and Credit Suisse's Crossfinder.
Other recent examples of liquidity aggregation services include TORA Crosspoint, initially launched in Japan by Tora Trading and now linking to around half a dozen Japanese pools, as well as ITG's POSIT Marketplace, which went live in Hong Kong in March 2010. Crosspoint has so far connected five brokers – including Credit Suisse, Morgan Stanley, Bank of America Merrill Lynch and Instinet – and three proprietary trading systems, namely Chi-X, JapanNext and Kabu.
While some brokers are reluctant to reveal which dark pools they are connected to, Credit Suisse takes a relatively open approach to liquidity-sharing agreements.
“We're running an agency business and we specialise in best execution for our clients. That means trying to get them as much liquidity as possible at the best price. So, in that respect, we would want to connect to as many dark pools as possible,” Hani Shalabi, head of AES for Asia-Pacific at Credit Suisse, said.
Nonetheless, he sees a risk from such connectivity. “There’s a risk that dark pool operators can use this to their advantage and tell their clients there is no need to deal with Credit Suisse as they aggregate our flows,” he explained. “That statement is not true, though. If another dark pool connects to us, they have a fleetingly small window of execution with our flow, and they only see what's in the dark pool at any given moment. They are not in any way aggregating all of our flows. If the other party's intention is to have clients connect to them first because they are using this as a marketing tool, then we're against it.”
Size is one criteria that Credit Suisse applies to the selection of dark pool partnerships. “They have to be commensurate in size because if someone else has a very small dark pool, it does our clients no good for us to get connected to them because its such a small percentage that we're not really achieving best execution by connecting to them. Meanwhile, for them, whenever they send us an order, it'll probably get executed. So we're doing them more good than they're doing us. A partnership has to be a win-win,” said Shalabi.
Deutsche's Lee also concedes that making known which dark pools one is connected is ultimately a marketing exercise. “The inference is that the more pools you're connected to, the more liquidity you can access, and the bigger benefit it will bring for the buy-side to trade through algorithms to access that liquidity. We believe that's important when you access the liquidity, but when you get into non-displayed liquidity, where our strength lies is in the anti-gaming technology which we apply on the algos,” he noted.
From an aggregator's perspective, Keith Ducker, chief investment officer of Tora Trading, said the decision on who to admit into Crosspoint rests mainly with clients, but he also emphasises the gatekeeping responsibilities of the pool operator. “When participants are interacting in DMA, for example, the opportunity for gaming is different than with resting blocks within the pool. So our focus is to make sure that our broker partners understand that we're monitoring participants to make sure that our anti-gaming approach is effective and we're policing the pool effectively,” he said.
Author: Jill Wong