The Impact of Dark Pools on Access to Desirable Liquidity

Emma Quinn, AllianceBernstein’s Head of Asia Pacific Trading discusses accessing liquidity through dark pools, aggregation and asset allocation.

Trading Volumes, Liquidity and Asset Allocation
I think that you’ll see trading volumes rise when you get an asset allocation back into equities, and people have more conviction in the markets. The reason that there’s just no liquidity in the markets is not because people are worried about exchange mechanisms or aspects like that, it’s about the macroeconomic environment and the allocation into equity.

I don’t think that we’re going to see volumes in other asset classes recover faster than allocation into equities as we’ve already seen that allocation change. People are either bullish or bearish, and are set for what they think is going to happen. And so we are in a position that people will just trade around their positions without making any significant move either way until we get some clarity on the macroeconomic environment.

The Rapid Expansion of Dark Pools and Access to Desirable Liquidity
We use dark pools to access liquidity for orders we would not normally place in the central limit order book. I think dark pools aid price discovery. There has to be post-trade transparency but once that happens you’ve actually got more transparency on a market than you normally would. In this sort of environment, because you’re not putting out so much into a central limit order book, what used to be 10% of average daily volume is now 30% of average daily volume, you’re obviously leaving more in a dark pool if your order size hasn’t changed. I do think dark pool liquidity aids you, as your expected cost is going to be lower and thanks to post trade transparency in dark pools the market sees a block trade that it would not have seen.

With regard to desirable liquidity, I think the onus is on the buyside to actually put in parameters that can minimize risk. Obviously, you don’t want to go into a dark pool blindly. The same thing could be said of going on to the central limit order book. The same thing can happen to you on a central order book as can in a dark pool, if you’re not smart about the way you trade in a fragmented environment you leave yourself open to be gamed.

Best Execution
We have an unbundled commission policy and as such our traders are not limited to paying based on a research vote. We have the discretion to use the broker that will give us the best execution outcome. This discretion is important and enables us to focus purely on the best execution outcomes for our clients.

Impact of Direct and Indirect Costs Imposed on Buy-side Traders by Liquidity Fragmentation
We spend a lot of time on quantitative trading strategies and both post and pre-trade cost analysis – we have pre-trade expected costs in our trader management system and we also look at post trade – both daily and weekly as it is not enough just to look at one trade in isolation as so many factors can contribute to whether you have got a trade right or wrong.

Some of the cost of fragmentation has already been borne by the buy-side and sell-side, such as having to have smarter systems and employ quantitative trading. Brokers are now wearing additional costs with some regulators looking to recoup the costs that come with the increase in surveillance costs for a fragmented market. The brokers may have made savings due to the fact that we now have multiple markets and with that came a compression on exchange fees, but they could well and truly be paying that out now to regulators.

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