Buy-side ready for leap in the dark

The results of February’s theTRADEnews.com poll reveal that 72% of readers will make greater use of dark liquidity this year. But volatility and reduced trade sizes mean traders will have to be more wary about how they use this increasingly important liquidity source.
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The results of February’s theTRADEnews.com poll reveal that 72% of readers will make greater use of dark liquidity this year. But volatility and reduced trade sizes mean traders will have to be more wary about how they use this increasingly important liquidity source.

There is no shortage of dark trading tools in the market, with even more to launch this year. As well as the plethora of dark pools and broker-owned crossing engines, the sell-side has developed dark liquidity seeking algorithms, while exchanges and multilateral trading facilities (MTFs) are also offering or introducing non-displayed trading functionality.

The London Stock Exchange, for example, will introduce a dark limit order type on 16 March, and is preparing to launch Baikal, a dark trading venue and liquidity aggregator, in June. Turquoise, the broker-backed MTF, plans to aggregate broker dark pools from Q1 this year, to complement its integrated dark and lit book.

“We are certainly going to use more dark liquidity,” said Simo Puhakka, head of trading at buy-side firm Pohjola Asset Management. “We are moving towards electronic and dark trading this year, especially broker-owned pools that are open to being probed by algorithms.”

“I’m not surprised that people are expecting to increase their usage of dark liquidity,” added Richard Semark, managing director, client execution, at UBS. “We have seen a big increase in the amount of client flow we execute within internal and external dark pools, particularly within the last few months.”

Semark points to NYFIX Euro Millennium, one of the first dark pools in Europe, as a case in point. “Volume has picked up in Euro Millennium since the turn of the year and this has caused other brokers to connect to it, creating a virtuous circle,” he said.

In December 2008, Euro Millennium executed a total of 250,853,752 shares, up from 44,843,798 the previous month.

To get the most out of dark trading functionality, investors will need to access as many non-displayed sources as possible to avoid missing out on liquidity and get the best possible execution.

“You can no longer afford to depend on, or place orders in, one venue alone,” said Tony Whalley, head of derivatives and dealing, Scottish Widows Investment Partnership. “It’s absolutely key for the buy-side to understand the algorithms available and work out how to get the most exposure without being seen.”

Many observers have also noted that with reduced trade sizes, dark pools are not necessarily used just for block trades any more.

Some traders, for instance, may look to dark pools for price improvement on large-cap liquid stocks by using algorithms to split up large trades and executing them at the mid-price, which would not always be possible on a lit venue.

However, with volatility still shaking the equity markets, Owain Self, managing director, head of European algorithmic trading, UBS, suggested that the buy-side is becoming more wary of how it interacts with non-displayed venues.

“Technology has allowed dark pools to open up to more flow, so clients’ focus has moved on to how we access and interact with dark pools, not just whether we do or not,” said Self. “Now that a wider range of participants can access these pools, sophisticated anti-gaming techniques are needed so clients can feel confident in using them.”

“We need to make sure we can capitalise on as many non-displayed venues as we can,” said Puhakka. “We will look to our broker list, not only to give us access to dark liquidity sources but also to help us feel comfortable with some of the tools associated with dark trading.”

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