ITG disputes ASX views on dark pools

Electronic trading market participants, including buy-side executives, have hit back at recent negative comments about dark pools made by the head of Australia's stock exchange.

They argue that unlit off-exchange venues in fact enhance transparency and help establish fair prices for equities, rather than distorting lit-market prices.

ASX chief executive Elmer Funke Kupper in August said he was concerned about the "growing dark pools and dark executions" in Australia. He also argued that as much as 25% of ASX volume during the first half of this year was executed in dark pools or dark executions.

This followed statements made by the ASX that dark execution results in widening spreads, higher cost for investors and worse price discovery – comments made in response to a consultation by the Australia Securities and Investment Commission (Asic).

These views sparked fierce debate among the trading community in Australia and elsewhere.

They were roundly disputed by Michael Corcoran, Hong Kong-based managing director of agency broker ITG, and Jason Lapping, head of Asia-Pacific trading at asset manager Dimensional Fund Advisors in Sydney.

"Our analysis shows that execution on lit markets has actually increased, not decreased, over the past 20 years to around 75% of total trading volume, from 50%,” says Corcoran.

The 25% figure cited by the ASX for dark pools’ share of volumes is also refuted by the 4% figure cited by Asic as of the end of December 2011, he notes. The 25% figure appears to include other off-exchange trades that represent order types categorised as ‘special crossings’ by the ASX but that are not actually done through dark pools, he says.

"This wide definition is not the same as 'dark pool' crossing, which is typically applied to specific mechanisms operated by brokers to match orders and report them to the market without pre-trade information leakage," says Corcoran.

In fact, ITG observes that ‘block special crossings’ on the ASX, which represent single matched trades by a broker of over A$1 million in value, have dropped to 5% this year from around 20% in 1992.

Dimensional's Lapping has seen a fall in the supply of block trades available for crossing globally. But equally, his team has had less need to trade large blocks, as the rise of algorithms and electronic trading allows the team to work orders without using a sales trader.

“We are using algorithms to place orders simultaneously in both the dark market and the lit ASX primary market,” he adds. “The advantage of trading in dark pools is that you don’t have to show your full order size to anyone, reducing the slippage of information.”

In Australia, all dark pool trades are reported in a timely manner, so they improve post-trade transparency far more than paper-based orders passed to sales traders, says Lapping. Under that system, the investor might not know the trade was done until after the market closed, he notes.

“Since orders in dark pools tend to use the lit markets as a reference to peg orders for trading, and since most trades are reported to the ASX or Chi-X instantaneously, I don’t think one can say that dark pools result in worse price discovery, wider spreads or reduced transparency,” says Lapping.

(Chi-X has been operating in Australia for a year as the first foreign-owned exchange competitor to the ASX.)

Dark pools should result in better ‘real price’ discovery, argues Lapping. Real price discovery should be observed at the execution price level, he suggests, instead of relying purely on the bid/ask quotes on the order book, because execution price is where the supply and demand curve of a stock has met.