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The RCM Experience

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 2011Kent 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.
FG: How much is fragmentation affecting your trading?
KR: The industry is not yet able to understand the full extent of how dark pools affect trading; by its nature, there is no clear record of all the trades executed in the dark. A lot of the trades done in the dark get no special discerning tag on the tape, and data capture standardization issues still abound. It is this ‘dark’ nature that protects the confidentiality of clients and their actions.
Fragmentation is a double-edged sword; it allows more competitive liquidity to enter the market which can bringspread costs down and it has spawned innovation. Yet, there may well come a point where it becomes cumbersome and challenging to retain perspective as can be considered the case in the US. Several dozen  venues, and the vast web of technology that is needed to piece the market back together present a number of challenges. However, fragmentation is part of the natural evolution of markets, and I expect this to continue in Asia, except in those markets where it is not allowed.
FG: What are the challenges of fragmentation, and how do you need to react to it?
KR: The challenge includes calculating the benefits using these tools, and gauging which brokers are doing the best job of getting the best price. As fragmentation in Asia grows so will the concern of how market data is being calculated and how this will impact pre and posttrade TCA benchmarks. This causes core market behavior assumptions to change with regards to which trades should or should not be included in market metrics. As aggregators step in, it also changes the behavior of the buy-side trader so they can view in real-time the FIX tags of ‘last venue’ to see where they are getting filled, which may lead to modifying whom they are executing with.
Fragmentation has affected trading making it more difficult for sales traders to source liquidity as they now need to check various pools for the best price before executing. Brokers’ technology allows them to do this automatically and much quicker than would be the case manually. As fragmentation increases, and more lit and dark venues arise, more and more technology development will be needed to ensure best execution.

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