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The Impact of Dark Pools on Access to Desirable Liquidity

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Instinet’s Glenn Lesko looks at the rise in popularity of dark pools in Asia and how dark aggregators should be used to most effectively access them.
The rapid expansion of dark pools has had a significant, positive effect on desirable liquidity. From our experience, dark pool liquidity in the Asia-Pacific region is largely high quality, and the participants that we have seen in dark pools are primarily large-scale global investors.
In Australia and Japan, the use of dark pools is largely driven by the same factors as in the rest of the world – faster exchange technology with typically tighter spreads and lower volumes have resulted in less depth in the market and reduced visible liquidity. Exchange competition has fragmented displayed liquidity in both of these markets as well, which was a factor that drove dark pool development in the US and Europe. Finally, in Australia, the block tradition of the market is also a factor, as it can be difficult to find sufficient liquidity on the exchange outside the top 10 or 12 stocks.
In Hong Kong, dark pools are adding value for very different reasons. Trading spreads are quite wide, so investors are saving spread as most of the dark pool trades are done at the midpoint. They also help investors avoid the transparency issues that result from the exchange’s display of broker names.
In terms of liquidity, we don’t see dark pools as increasing fragmentation as much as fulfilling genuine market needs. Brokers have always had their own liquidity; that liquidity was fragmented whether it sat on their block desk as was the case historically or is placed in their dark pool as it is today. The fact is, trading via displayed exchanges has never been the best way to access all liquidity in the market.
Tools and Systems Available to Aggregate Liquidity
Today there are only a few dark pool aggregators available in Asia, which is similar to the situation in the US four or five years ago. This may change in the future, but currently the big brokers – which only relatively recently deployed their dark pools in Asia – are focused on getting returns from that investment rather than aggregating other firms’ dark liquidity for clients.
The dark pool aggregators that are available offer access to multiple venues where dark liquidity resides, be it in a bulge bracket-broker dark pool, agency-broker dark pool or on exchange (as ‘hidden’ or ‘iceberg’ liquidity). The venues accessed by these aggregators are generally fully customizable, and are therefore leveraged by a wide range of traders – from block traders looking to get the largest possible block closest to the price at which the order came in, to those benchmarked to volume-weighted average price (VWAP) or participation weighted price (PWP). We measure the performance of our dark aggregator every month to see how it is performing versus implementation shortfall, PWP and VWAP.
Dark aggregators typically prove to be to most effective way to access as much dark liquidity as possible. Dark pool penetration is somewhere between 5-10% in Japan, about 3% in Hong Kong and 3% (and growing fast) in Australia. However, in Q1 of this year, clients using our dark aggregator executed 18% of their flow in dark pools in Hong Kong, 14% in Australia and in excess of 11% in Japan (rising to 22% if PTSs are included). While many point to the relatively low dark liquidity usage figures in Asia- Pacific, the simple fact is that the results can be significantly higher for those using the right tools.

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