Capital Group’s Brian Lees is driving efforts to ask more questions of brokers, and for more data on where an order is shown before it executes, but can the buy-side handle the resulting deluge?

The current work you are doing on venue reporting analysis
Our first push was simply to try to collect information about ‘where’ we were executing and a little bit about ‘how’ we were executing, namely, did we post or did we take liquidity. So having done that, the question was where do we go from there? And as such, the topic of requesting more data on where we didn’t execute and what order types were used started to be raised by some representatives on the FPL Americas Buy-Side Working Group. Some participants had already started down this road with brokers, asking for information relating to post-trade about where their orders were sprayed out to by the algorithms and what types of orders were placed on exchanges and also which exchanges they were on, etc. So that’s where the conversation began and that’s where we reached out to Jeff Alexander and Linda Giordano, because Barclays had already spearheaded this conversation.

What we are looking to achieve either in real time or post-trade, is whether we can standardise a format for brokers to tell us how our order interacted with the market, including when the order was placed, what order types were used, where it was placed in the markets and whether or not we got hits. The concern with this is not so much can we get it, because if we sign enough non-disclosure agreements we can get the information from the brokers. Some brokers have concerns about that information getting out and somebody reverse-engineering their algorithms, but from the buy-side perspective, I think the biggest concern is whether we can manage the volume of data that we would get.

The resources to store and analyse data and make some sort of good use of it
With the original data that we were getting, on where the execution took place, we talked a lot about this with smaller firms who were using TCA vendors to help them analyse this information. With this type of information, if we went a step further, the brokers would not want us sending that out to TCA firms, because it shows their methodology for how their algorithms behave. I was in New York several weeks ago and took the opportunity to meet up with Jeff and Linda while we were there. We invited Jeff to join one of our conference calls for the buy-side committee, which he did, and he talked about what they’ve been proposing. He showed proposals for both the real-time collection of data, via FIX messages, actually proposing a whole new FIX message to be created for this purpose, which could then be sent in real time. Or, alternatively we could standardise a format for collecting the information post-trade which, as a spreadsheet, would then tell us what we want to see. We’re trying to standardise how you ask for the data and what format it is going to be in, by creating best practices for how to get the data from the brokers. That way the brokers don’t have to keep coming up with a different format for every client that asks for it. The best practices do specify that the ISO MIC codes would be the standard for identifying the exchange that you executed on, but we said nothing about what you should do with the data once you get it.

Exchange involvement in the conversation
We did talk to some exchanges when we were first trying to standardise how to identify the exchanges, because when we first standardised the MIC codes, they did not cover all the exchanges, this was due to the fact that they hadn’t all registered with the ISO organisation and we wanted them to.

We had a little bit of trouble in differentiating the dark order books from the lit order books and some of the exchanges that have both. These exchanges consider themselves a hybrid book, and they didn’t want to be known as two different things. We didn’t have a way to differentiate the dark and the lit flow without introducing yet another FIX tag. That back and forth added to the conversation as part of the registration authority’s decision to come out with the new market segment concept, which says you can have an exchange defined and have child MIC codes that differentiate different segments of the market. We’re beginning to start conversations with exchanges about this topic, but that’s the extent to which we’ve had any discussion with them.

Broker willingness to participate in the process
The first half of this, just getting the information about where you executed, the brokers didn’t have any problem, because it’s public record once it executes. When we started talking about the more detailed reporting, they did raise a concern about the information being sent out and NDAs so that, you, as a client, are not going to send the data out to a third party. But because other firms had already started down this road we talked about the purpose of this, which was just to have someone looking over their shoulder to make sure that they are acting in the best interest of the client and not potentially favouring rebates over best execution; they can’t really argue with that logic. Somebody should have some oversight as to whether or not the right decisions are being made.

RCM’s Head of Asia Pacific Trading, Kent Rossiter, unmasks the Asian trading scene, sharing insights into how RCM navigates the unlit landscape, identifying the effects of dark liquidity and highlighting ways brokers can facilitate better buy-side decision making.

FIXGlobal: What are the main benefits of dark liquidity in Asia?

Kent Rossiter, RCM: One of the major challenges in Asia has always been accessing liquidity without other parties in the market taking advantage of your position and your need to complete the order. In cases where liquidity is scarce, knowledge that a relatively large order is being worked can expose investors to various risks. In such situations, it is  advantageous for knowledge of the deal whilst it is being worked to be discreet until the order is filled. In dark pools run by brokers we can get priority on our orders through queue-jumping.

Dark pools support such an approach as they allow large block orders to be worked without showing size. In this way, trading in dark pools allows a trader to access a broker’s own internal order flow, without being gamed by the market that would otherwise risk non-fulfillment or less efficient pricing. As a result, size trading becomes the norm in dark pools and a trader gets to see blocks that may never have been available otherwise. With no information leakage we are not disadvantaged by the fading you see on lit venue quotes. From a personal perspective, the challenges that arise from dealing across a number of venues and the resulting increased use of technology make the role more exciting and satisfying.

FG: How do you limit information leakage in dark pools?

KR: With the exception of broker internalization engines, the trade sizes found in dark pools are often multiple of what they are on the exchange. So having fewer, but larger prints reduces information leakage, and in many cases we can get done on our size right away. Minimizing the number of times a print hits the tape reduces the chance of this footprint being picked up and working against the balance of your order. That said, broker internalization engines do their part well, keeping any spread savings among the two broker’s clients instead of giving it up to the general market.

FG: If you decide to seek dark liquidity, how do you decide between broker internalizers and block crossing networks?

KR: The type of dark venues being used for various trades (i.e. between block crossing networks and brokers) are different. As I mentioned, brokers for the most part are matching up little prints that otherwise would have been time-sliced in the general market, and when using these venues the goal is often to save a few basis points along the way while you work an order. You are not often micro-managing each fill, but through the process we are getting spread capture and price improvement. The type of stock you are often trading in these internalization engines are often larger, more liquid stocks; the type of orders often worked by algos.

Block crossing networks on the other hand, while still matching up electronically, are probably more confidential, and take up the function of what brokers still do upstairs - putting blocks together - so size is the real focus here. Both types of dark pools use the primary market for price sourcing since the vast majority of trades get printed at or within the best bid and offer. As the primary markets become too thin, it can cause price formation problems.

While it is not specific to the consideration of dark pools as an extra execution venue, we have to consider potential increased book out costs if we do use dark pools (except via aggregators, since we would only be using one counterparty), just as we have had to for years when deciding whether to execute a block with a single broker versus multiple counterparties. As dark pools proliferate there is an increased chance that we may not have part of our order in that pool at just the right time to take advantage of flow that may be parked there. Dark pool aggregators are aiming to provide the buy-side solutions to this.