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Asia’s market structure creates demand for increasingly granular trading information – as Kent Rossiter, Head of Asia Pacific Trading Allianz Global Investors and Michael Corcoran, Managing Director ITG discuss, FIX can help.

Asia Pacific faces different liquidity challenges to other regions, particularly given that spreads are often much wider and are therefore an even more significant contributing factor to overall trading costs (See Chart). As the trading environment evolves in the region and the focus on managing costs grows, the requirements for transparency and feedback on trading increases. This is happening in parallel with the evolution of new trading venues in the region, particularly dark pools. Buy-side traders now want a greater level of detail on their dark pool fills to help them understand the behavior of their orders and manage their execution venues proactively to get the best trading result.

Kent Rossiter heads up the Asia Pacific trading desk of Allianz Global Investors, and is constantly looking for ways to improve the efficiency of their process and minimise the costs of trading. From his perspective, while post-trade TCA is now well-established, a particular growth area is the requirement for more detailed data on a shorter timeframe. He explains “We as buy-side traders are now trading an increasing amount of our orders ourselves using the electronic tools available, and when we do so we want more granularity and data fed back to us: which venues are our orders being executed in, at what price, and how aggressively. We want information that helps us adjust strategies on the fly for better trading outcomes, or quickly review the results so we can manage our future performance.”

One result of this is new demand in the region for analysis of maker/taker indicators on orders so that a trader can identify how often they are crossing the spread to find liquidity. Allianz Global Investors has been working with ITG and other brokers in the region to implement support of maker/taker analysis to help the trading desks improve their insight into market conditions and get more transparency into the behavior of their orders in dark venues.

Understanding Maker/Taker
Understanding whether an order is making or taking liquidity is important, particularly in wide-spread environments such as many of the Asian markets. Michael Corcoran, Managing Director of ITG, says “Traders want to know instantly whether they are providing liquidity or taking it, instead of retrospectively needing to compare fills and timestamps manually against what the market was trading at. This can be very useful information to help them adjust the trading strategy in real-time to the market conditions and the liquidity available. It can also help determine what kind of ‘throttle’ they should put on their strategy or their algo to find the right level of aggressiveness for the orders they are working. In addition to that it can also be a very valuable tool for sell-side firms, helping to refine the development and rules of algorithmic strategies and improve strategic ideas that will work for certain clients or order types.”

This is of growing relevance in a multi-venue environment, for example in Asia where over the past few years a lot more broker dark pools have been developed. Many buy-side firms now choose to use a dark aggregator to help improve their efficiency in accessing multiple venues, and here some kind of maker/taker liquidity analysis can be a helpful data point for assessing the type of outcome a trader is getting in those pools. Corcoran explains “Both ITG as a dark aggregator, and our buy-side clients themselves, want to understand whether orders are consistently making or taking liquidity in a specific dark venue so that the impact can be assessed – for example if our client’s orders always take liquidity in a certain venue we would review that to understand why. If we can pass that data directly back to the clients they can then make a decision about whether they want to be removed from that venue or change the distribution of their order flow across different pools. Likewise, if we see orders taking liquidity then see an unexpected change in the stock’s trading profile, this can be a useful warning indicator about the participants in a specific pool.”

FIX Tag 851 – a Potential Solution
A specific FIX Tag, 851, or Last Liquidity Indicator, has been developed by FIX Protocol Ltd (FPL) as an identifier of maker/taker behavior. The US appears to have the most established support of liquidity-indicating tags with exchanges able to pass the data back to brokers and most of those brokers able to pass that on to clients. In Europe, likewise the large exchanges and brokers can support this, although there is less among the mid and smaller brokers.

However, in Asia the tag is sparsely supported, if it all, by the exchanges, alternative lit trading venues and many of the broker dark pools. Firms therefore have to come up with interpretive solutions and workarounds to give their buy-side clients a higher level of detail and transparency on their trading, particularly in dark pool aggregation.

Rossiter would prefer an industry-wide approach to improving transparency and the availability of maker/taker data which includes vendors, brokers, and most importantly the exchanges “Typically the actual FIX tag for this information is supposed to be generated by the exchange or trading venue, and it is passed to the brokers who need to be able to identify and accept that tag and then pass it into the vendor EMS or OMS platform that the client is using. So there are a number of parties within the workflow who are affected and they need to collaborate to bring in changes. An industry-wide adoption of the relevant FIX tag would definitely be a good solution”.

Michael Corcoran of ITG sits down with Jason Lapping, Head of Asia Pacific Trading for Dimensional Fund Advisors (DFA), to discuss the practical impact of electronic trading and dark aggregation on his trading process.

Michael Corcoran, ITG: DFA is one of the largest users of electronic trading techniques in Asia Pacific. Why have you chosen this model and what benefits does it bring?

Jason Lapping, DFA: The primary driver for us using electronic trading is to give us full control over the trading outcomes. DFA’s unique process of generating investment returns is highly focused on the overall returns of an investment decision, and that includes the impact of trading. Portfolio managers generate orders for the trading desk but provide some flexibility over what to purchase on a specific day. This means we can be patient, exploiting the opportunities and liquidity available at any given moment. As a result, around 90% of our global trading volume is electronic. In Asia Pacific, that number is even higher, with over 95% of trading managed by our own traders using DMA and algorithms accessing both lit and dark liquidity simultaneously.

Dark and alternative sources of liquidity also form an important part of our strategy. DFA manages in excess of US $240bn, so we are often interested in trading a large percentage of a day’s volume in a stock. We utilize dark pools to try to achieve this in a way that does not signal to the market. Most of our dark pool fills are small, but cumulatively they amount to a significant extra size traded without signaling the extent of our interest to the market.

We generally trade in dark and lit simultaneously as there is an opportunity cost to placing an order only in the dark. So for us dark liquidity is particularly useful as a complementary strategy.

Firms often describe what they do as trading securities, but in fact what we are doing is trading liquidity. And anything that helps us interact with more liquidity is really important. Therefore in the developed Asia Pacific markets, about 10-15% of our total executions are done in dark pools. We believe this helps reduce implementation costs while getting more done. Both of these elements benefit our investors.

MC: Has the move to full control of the trading process been explained to your investors and do you find it’s a differentiator for DFA?

JL: Trading is very much a value-add in DFA’s overall investment process. So our engagement with clients involves explaining that we have an integrated investment process where portfolio managers work closely with the trading desks, giving them a degree of flexibility. When the market is not going our way, this flexibility allows DFA traders to be patient on a specific stock at a given point in time. When the market is going our way, it allows our traders to be opportunistic. We execute at prices where it makes sense to do so, not because we have been told to get the order done today.

What this ultimately means is that trading can start to add value, rather than being a drag on a portfolio’s returns. The cost of implementation can be significant, and our job as traders is to minimize the gap between the theoretical and actual returns of portfolios. I think that many of our clients find this is a differentiator for DFA, and it is potentially a reason to choose us over another investment manager.