Taking liquidity away from the public order book poses a threat to the buy-side’s ability to discover prices, say top investment managers at the TradeTech securities industry conference held in Paris this week.
While brokers are keen to extol the virtues of their internal crossing engines, arguing they provide both price improvement and reduced market impact, some buy-side CEOs are concerned that the proliferation of off-exchange trading will diminish the ability to value assets effectively.
“The existence of places where you can trade without disclosing the quantity, involvement etc. is not a benefit to anyone on the buy-side and puts end-investors in jeopardy,” said Francois Bonnin, CEO of John Locke Investments, during a panel discussion on how the buy-side is adapting to the changing investment environment.
Attracting the flow of liquidity away from displayed venues takes away the buy-side’s ability to discover prices, argued Jean-Pierre Aguilar, CEO of French hedge fund Capital Fund Management. The development of the European equity options market – which was once dominated by on-exchange trading, but where off-exchange crossing became increasingly prevalent –
provided a salutary lesson, he said. “Because the members were allowed to cross the orders outside the market, the liquidity on exchange dried up, and now exchanges are just used to eliminate counterparty risk,” he said. “In a sense, the price discovery process is no longer available to the buy-side.”
When asked whether this meant the same could happen with dark pools in the equities world, Aguilar said much depended on regulation. “If you look at the US options market, all the liquidity has remained on the exchanges,” he observed, “That is because in the US members are not permitted to cross away from the order book, and the price discovery process remains public.”
Aguilar added that it is important to keep the price discovery process as transparent as possible. “The key point is to keep the price discovery mechanism widely and publicly available and create a national best bid and offer so you can gather all the bids and asks of the order books together and see where the price and the demand is,” he said. “That will encourage competition and innovation in terms of how to access the market. However, if this process is not kept very publicly available then you will see the liquidity drain out of the market.”
Read this story in full plus more coverage of TradeTech 2009 in The TRADETech Daily in our publications section.