US institutional investors are concerned about the market quality implications of growing off-exchange trading volumes, but are unclear on how much of their own trades are executed in the dark, according to TABB Group.
While the research firm’s eighth annual benchmark study of US institutional equity trading found 60% of survey participants believed off-exchange activity was now impacting market quality, almost two-thirds (63%) could not confirm the percentage of their algorithmic flow which is executed in dark pools.
The study also found around two-thirds of buy-side firms “had trust issues” with dark pools. Institutional investment firms in the US and globally carried out intensive due diligence on their use of dark pools and brokers’ order routing mechanisms after Pipeline Trading Systems was fined[/newsarticle.aspx?id=7232] in October 2011 for failing to disclose that the vast majority of its orders were executed by an affiliated trading firm rather than buy-side counterparts.
In June, the US Securities and Exchanges Commission (SEC) investigated alleged shortcomings in how Liquidnet protected information about clients which use its block trading platform. In October 2012, the SEC fined Boston-based eBX US$800,000 for failing to inform participants in its LeveL ATS alternative trading system that orders were being routed to a third-party technology firm, Citi’s Lava Trading, which fed the information into its order routing business.
TABB Group research analyst Cheyenne Morgan said current practice in use of algorithms to access dark pools made it difficult to track execution. “Most traders access dark pools by using algorithms, which can make visibility into final execution venues difficult. Each algorithm is typically connected to several dozen venues and may route to multiple destinations before finding a suitable match, making transparency problematic. Adding to the challenge, traders typically use multiple algorithms throughout the day for various orders,” she said.
The TABB study also revealed concerns among US buy-side firms over the growing consolidation of sell-side execution services, with almost seven out of ten survey participants asserting the importance of maintaining anonymity between high- and low-touch services. Noting declining commission wallets in line with trading volumes, Morgan said, “Maintaining client trust while consolidating multiple roles into a single-touch point will no doubt prove challenging but is a must in today’s environment.”
The study is based on interviews conducted in August and September 2012 with 66 head traders of US institutional equity management firms controlling a total of US15 trillion in assets under management.