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Dark Horses Down Under

As the issues surrounding dark liquidity grow more and more contentious, Steve Grob, Fidessa’s Director of Group Strategy, looks at the Australian trading landscape, how this type of trading has evolved and what the dark future holds.
Over the past few years, much attention in Australia has focused on the competition between ASX and Chi-X. But, in fact, multi-venue trading (via dark pools) was available to Australian investors long before Chi-X ever opened its doors back in November 2011. The term ‘dark pool’, however, has now become a catch-all phrase that describes a variety of activities that match trades but do not distribute pre-trade prices. Partly because of their name and partly because they are misunderstood, dark pools have attracted great controversy worldwide, and Australia has been no exception to this. So, what does the Australian dark landscape really look like, who is in it and what value does dark trading really bring to the market?
In 1997, ITG launched POSIT, a pre-market VWAP cross, Australia’s first alternative venue. However, it wasn’t until 2008 – anticipating the end of the ten-second rule1 – that Liquidnet followed with its buy-side crossing network, and finally Instinet with its BLX crossing network in 2011.
Likewise, broker dark pools were also around before Chi-X was born. UBS PIN (Price Improvement Network) launched in 2009 with other major brokers quickly following. These days most of the big brokers in Australia operate dark pools, although UBS PIN remains the biggest.
Finally, ASX’s own dark pool, Centre Point, was launched with much fanfare in 2010, and it is thriving (see diagram 1); it in fact has greater market share than Chi-X. To illustrate the complexity of these issues though, at a conference in Melbourne in May 2012 ASX chief Elmer Funke Kupper warned of the dangers dark pools presented to the Australian trading landscape, even though ASX earns 0.5bps on the AU$100 million-odd worth of trades executed on its venue every day.2

Genesis of Dark Pool Trading
Institutional buy-sides have always preferred to cross their order flow with other buy-sides that have the ‘natural’ other side in the stock they are looking to buy or sell. The reason for this is anonymity, or not divulging their trading intention to the market at large. The larger the order size the greater the value placed on this anonymity. Dark pools provide exactly this – but have they always been available or are they a new luxury brought about by the wonders of electronic trading?
In the days before widespread computer usage, if an institution wanted to move a big line of stock, and didn’t want to send it down to the exchange for fear of moving the market, they’d call their broker. Often the broker would call their internal counterparts to see whether they, or a client, was buying or selling a similar block and would execute an ‘upstairs’ trade at an internally negotiated price. Depending upon the skill of the broker, this provided a high degree of anonymity and certainly more than would be achieve by just dumping the order on a lit market for all to see.
It was a natural step then for brokers to employ computers to automate this upstairs activity so as to increase its effectiveness and reduce their reliance on human memory. The result was a dark pool that matched different client orders away from the public gaze of the lit markets.
When is a Dark Pool not a Dark Pool?
The terms ‘internaliser’ and ‘dark pool’ are often thrown around synonymously when talking about non-lit trading, particularly in the Australian media. Correctly speaking, however, an internaliser describes a firm conducting a specific activity where the broker is looking at incoming client orders and choosing to cross them against its own book. This can be contrasted with a broker crossing network, which is anonymous to both the clients and the broker – neither can see the orders inside the pool until they have been executed. A third category of non-lit activity includes dark books operated by venues that provide a similar service. And, finally, some venues permit dark order types (where part of the order is hidden) to intermingle with their lit liquidity.
Not only are there many types of non-lit or dark venues but, to make matters worse, each is defined and treated differently by various regulators around the globe. No wonder then that dark pools tend to be perceived suspiciously (see diagram 2).

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