The ability to stitch together the liquidity residing in both public dark pools and brokers’ internal crossing engines is high on many European buy-side traders’ wish lists. But while some trading venues are responding by establishing dark pool aggregation services, regulatory and commercial hurdles could hamper progress.
It was once thought that bilateral links between broker dark pools would provide the main solution. But although some brokers have been open to the idea – for example agency broker Instinet and bulge-bracket firm Credit Suisse linked their European dark pools in 2008 – most brokers are understandably reluctant to open their internal crossing engines to competitors.
“In Europe, Merrill Lynch is not currently looking to establish shared dark pool access with other brokers, as we feel this may compromise the quality of our existing pool and provide further levels of fragmentation,” said Ian Martin, director, execution sales, Merrill Lynch.
Brokers that do establish links may constrain the flow available to their rival’s crossing engines, which could limit the usefulness of this aggregation method to the buy-side. “My understanding is that the liquidity sharing arrangements that are currently in place are generally on a smaller child-order level, so there is still a rational reason to send large orders to each of the individual brokers in a liquidity sharing relationship,” said Peter Baillie, senior equity dealer at Edinburgh-based asset management firm Martin Currie Investment Management.
There could also be regulatory hurdles to establishing broker links in Europe. Some observers have questioned whether regulators will force brokers accepting flow from other brokers to register as multilateral trading facilities.
Trading venues have tried to offer a solution to fragmentation of non-displayed liquidity by proposing dark pool aggregation services. The London Stock Exchange’s Baikal dark pool, scheduled for launch in June, plans to offer the buy-side access to multiple broker pools as well as public dark books and displayed trading venues. According to Baikal CEO John Wilson, the platform is currently in discussions with brokers about offering connectivity to their internal pools.
In addition, pan-European multilateral trading facility Turquoise is planning to launch its own aggregation service this year. “We’ve had a good amount of interest and firm indications from brokers that they are going to be part of the liquidity aggregation initiative,” said Duncan Higgins, head of client relationship management at Turquoise. He added that the service would not be limited to Turquoise’s nine founding banks.
While Merrill Lynch eschews links with other broker dark pools in Europe, Martin said the firm is embracing aggregation services such as Turquoise’s. “We believe this maintains the quality of our dark crossing without any direct risk of information leakage,” he commented.
However, brokers’ desire to control access to their crossing engines could make some cautious about connecting to aggregation services. “The success of dark pool aggregation services depends on how they interact with other dark venues,” said Owain Self, head of European algorithmic trading at UBS. “We are in control of who accesses PIN [UBS’s internal dark pool] and its matching logic, and we are not going to open that up to just anyone.”
Aggregation problems are not limited to broker dark pools. Current regulatory restrictions prevent different types of dark order interacting. For example, orders sent to Turquoise’s new mid-point dark order facility that are smaller than MiFID’s large-in-scale restrictions will not be able to interact with the large-in-scale dark orders or displayed orders on Turquoise.
“It creates additional fragmentation,” said Toby Bayliss, head of algorithmic and program trading, Europe at agency broker Sanford C Bernstein. “If you want to access all of Turquoise’s dark liquidity, for example, you would in effect have to send out two dark orders to Turquoise.”
“We’re looking at how we can provide additional services that will help members with the complexities of trading into the separate pools of liquidity,” said Higgins.
However, because of the various hurdles to aggregating dark liquidity, the buy-side will have to wait longer for better linkages between the various types of dark venue. “We are not going to reach that stage any time soon – certainly not until we get some clarity about what is allowed in dark pools and how brokers are allowed to interact,” said one market participant.