Dark-pool trading volumes soar amid uncertainty

Uncertainty among equity investors has driven record dark-pool trading volumes in Asia-Pacific, say agency brokers, even as trading costs on lit venues appear to be stabilising.

It comes as data shows that average daily turnover fell on the primary lit exchange venues in Hong Kong, Japan and Australia last month.

ITG, an agency research broker, notes that its dark-pool liquidity aggregator Posit Marketplace saw crossing volumes nearly triple in the region in the second quarter compared with the first three months of this year.

It says this is being driven by higher numbers of institutional buy-side clients on its platform trading Asia from the US and Europe, as well as a jump in adoption from trading desks within Asia-Pacific.

“At a point when markets are very volatile we are seeing institutional traders wanting to use all the tools at their disposal to help find liquidity and manage costs,” says Clare Rowsell, Asia-Pacific head of client relationship management and marketing for ITG. “That means there are strong volumes in regional dark pools at the moment, and that trend is continuing.”

She reasons that institutions are eager to save on bid-offer spread costs given that market volatility has driven spreads wider.

Meanwhile, institution-only dark-pool platform provider Liquidnet says its daily buy-side order volume has jumped 22% month-on-month so far in August, with its trading volume having tripled in Australia and risen 40% in Hong Kong.

Lee Porter, head of Liquidnet Asia-Pacific, tells AsianInvestor there has been an imbalance over the past few days with more sell than buy orders.

“Clearly we are seeing a period of higher volatility where there has been recently far more selling pressure than buying,” he says. “There are various reasons for the rise in selling, including institutions being mandated to sell and perhaps investors applying a contrarian investment strategy.

“Periods of high volatility also favour high frequency trading strategies, which are active in some Asian markets. These strategies can present challenges to traditional long-only investors and fundamental hedge funds.”

The firm says average execution size in Asia-Pacific has stepped up from $1.1 million last month to $1.2 million or $1.3 million this month (it hit a high of $1.5 million around May). "This shows that when people find liquidity and an execution opportunity they want to take advantage of it," adds Porter.

ITG says institutional investors using Posit Marketplace have seen an average price improvement of 13 basis points on their trades so far this year.

But it also notes that average trading costs on lit venues across Asia and Australia are stabilising around 45-48 basis points on both a year-to-date and three-month rolling average basis.

Australia has the lowest average trading costs in the region, with a year-to-date average of 36bp and a mean of 34bp in the second quarter of this year.

Australia is acknowledged as an early adopter of electronic trading in Asia, and with the threat of competition the ASX exchange has also improved market efficiencies. “This has been set against a backdrop of a fairly strong investment environment relative to other global markets, which has helped maintain turnover,” notes Rowsell.

Japan – another market that sees strong competition from alternative trading venues and improved technological efficiency – records the next lowest costs, although the March 2011 earthquake and tsunami and other macro factors edged average costs up to 42bp in the past quarter, against a full-year 2010 average of 40bp.

Interestingly, Singapore has shown the biggest drop in trading costs, at 42bp across the second quarter against 2010 full-year average of 51bp.

ITG partially puts this down to SGX improving efficiency, latency and general market structure in a drive to attract volumes from high-frequency traders and investors. Factors include technology upgrades, and possibly also a reduction in tick sizes and the elimination of a lunch break.

But ITG notes that average trading costs have risen to 54bp in Hong Kong, which is among those markets which saw a drop in trading volume last month (although trading turnover spiked dramatically earlier this month).

ITG says this rise in costs comes despite, or perhaps because of, the strong IPO market in the city so far this year. Hong Kong has already seen 47 IPOs list this year valued at a total of $23.8 billion, according to data provider Dealogic. That is more than half the number of deals from all of last year, which is the highest on record in volume and value.

“At times when demand for IPOs is good, the market is more heavily skewed in one direction, which pushes the average cost higher as those willing to buy will cross the spread or accept higher costs to get the order done,” explains ITG.

The firm points to the different approaches being adopted by the central exchanges in Singapore and Hong Kong. “These numbers may be an indication that efforts at an exchange level in Singapore to improve efficiency are starting to benefit investors, while Hong Kong is more reliant on its position as the IPO market of choice to drive volumes,” the firm finds.

Meanwhile, Taiwan’s cost profile has remained stable at 54bp, while Korea is showing some volatility in costs at 63bp against a full-year 2010 average of 57bp, possibly due to global uncertainty.