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.
ITG’s Kevin O’Connor sorts the nuts and bolts of real-time TCA and discusses specific strategies with Steve Peterson of the Teacher Retirement System of Texas.
Monitoring and reporting on trading performance in real-time is not a new concept. Trading profit and loss (P&L) calculations and supporting transaction cost information has been available in most Execution Management System (EMS) and some Order Management System (OMS) platforms for a number of years. However, integrating the calculations and information into trading workflows presents a unique problem. Specifically, how do you design a monitoring and feedback system that is fast, easy to use and provides information that will help traders make smart strategy choices. Real-time monitoring can be broken down into three main categories:
Transaction Cost Analysis
Market Conditions (Prices, Volumes, etc.)
Transaction Cost Analysis (TCA)
In its simplest form, real-time TCA consists of comparing execution prices to various benchmarks, such as arrival price, interval volume weighted average price (VWAP) or previous close, and displaying this information back to users as a realized P&L number. In addition to realized P&L, unrealized P&L (which uses a proxy price for the unexecuted portion of orders) can be shown, providing a trader with a view as to the potential exposure remaining in their orders. When analyzing individual orders, real-time TCA tools plot actual executions against market prices to provide a visual representation of the execution “footprint”. When analyzing multiple orders, the tools focus on generating alerts or highlighting performance outliers.
Risk monitoring tools analyze the risk characteristics of a residual tradelist. This typically includes metrics such as total risk, tracking error, beta and sector imbalances. Real-time risk monitoring is used by traders that are looking to minimize total risk while working a program or a list of securities. These tools are also used by portfolio managers and trading desk management to monitor the status of portfolio transitions.
There are many ways for traders to monitor market conditions. The simplest metrics quantify actual market volume, prices and volatility. For volume monitoring, a comparison of current volume to historic volume is often provided. Order-by-order and aggregate participation rates are also generated, providing traders with a view of their total market participation. For market price monitoring, individual security prices can be compared to industry, sector and market movements. Volatility is another analytic that can be analyzed in real-time. Comparing realized volatility to historic volatility gives traders some perspective on the relative difficulty of the current market conditions.
To make this type of real-time monitoring most effective, it should be available for all electronic trading flow, not just the transactions staged through an EMS. By way of example, Investment Technology Group provides real-time monitoring capabilities for all transactions that flow through broker-neutral platforms. Traders can now get a consolidated view of their trading activity even if they don’t stage all transactions via a single EMS. Using the monitoring capabilities available, traders can quickly and easily monitor real-time market conditions and trading P&L for all of their electronic trading.
I recently spoke with Steve Peterson, Trader and Transaction Cost Analyst specialist at the Teacher Retirement System of Texas about his experience with real-time monitoring tools.