Buyside Struggles to Stay Current
Opinions and Knowledge of Dark Pools Mixed
July 2008
Buyside traders report that when it comes to dark pools, they're, well, in the dark. They say they aren't sure what dark pools do when they access other pools to try to find liquidity for orders within their own system, according to a recent Traders Magazine survey. Some 38 percent of buyside traders said they weren't even aware that some pools send out or receive either immediate-or-cancel orders or electronic indications of interest from other dark pools.
These revelations come as more alternative trading systems access one another with both firm orders and indications as part of the hunt to find the contra side for orders. This cross-pool liquidity-seeking effort is a growing trend.
Some refer to pools that are willing to send or receive certain order information, typically indications or so-called "liquidity alerts," as "gray pools" rather than dark pools because some information about orders is sent to the trading engines of other pools or venues. ATSs say indications are usually sent with the permission of those placing the orders. In May, dark pools represented 6.3 percent of the industry's average daily volume, according to research firm TABB Group.
However, the trend of dark pools reaching into one another is apparently not buttressed by sufficient education among those using these pools. A full 42 percent of buyside respondents said they didn't know if they were sufficiently informed about what dark pools did with orders they rest in those pools, while 13 percent said they definitely did not know what dark pools do with their flow. Twenty-two percent said they considered themselves sufficiently informed. Another 9 percent said they actively control what happens with their flow. Finally, 14 percent said they did not want or need to get involved in these decisions.
Based on the survey results, buyside traders do not speak with a single voice about what dark pools should and shouldn't do to find liquidity. Indeed, the buyside is conflicted.
Thirty-seven percent said dark pools should send out both indications and IOC orders to scout for liquidity. Those in the opposite camp had an only slightly smaller response rate. Thirty-four percent said dark pools shouldn't send out either indications or IOC orders. Another 15 percent thought dark pools should send out only IOC orders, while 14 percent voted for just indications.
When it comes to receiving versus sending information to other pools, the responses of buysiders revealed a clear bias. Receiving information into a pool was deemed acceptable by most traders. Sixty-five percent of the respondents who answered this question said it was fine for dark pools to receive IOC orders from other pools. The same portion of traders said it was fine to get indications from other pools. Ten percent of the survey respondents did not answer this question, suggesting that they did not like the idea of dark pools forming connections of any kind with other dark pools.
Sending out information about orders was deemed a trickier proposition by these traders. Not quite half the respondents, 48 percent, said it was okay to send out indications, while 54 percent said they were fine with a dark pool sending out IOC orders.
Asked how changing practices at some dark pools might impact their trading decisions, 41 percent said they would use dark pools that send out indications cautiously under specific circumstances, while 18 percent said they would definitely use them because they were searching for liquidity elsewhere. Twenty-three percent put their foot down and said they wouldn't use them because of information leakage concerns. Another 18 percent admitted they weren't sure what they thought of dark pools sending out indications.
The online survey, which was sent to 4,990 buyside traders by email in early June, generated 130 anonymous responses. The response rate was 2.6 percent. Almost 68 percent of the respondents were traditional money managers, while 31 percent were hedge funds, and under 2 percent were pension funds or endowments.
The majority of respondents, 52 percent, said they access dark pools and crossing systems both directly themselves as well as through algorithms. Twenty-five percent said they don't use dark pools and crossing systems, although it is possible some of those firms use brokers that access dark pools.
Most traders said they use dark pools for both block orders and smaller flow. This group accounted for 65 percent of the survey respondents. Another 24 percent said they use dark pools and crossing platforms only for blocks, while 11 percent said they use these pools solely for small flow.
The survey also generated two-dozen written comments. One trader, who noted that dark pools are often made to sound ominous in the press, pointed out that they are simply an "outgrowth of large banks' internalization programs that allow customers to interact with what might possibly be better liquidity within the market spreads, without subjecting the release of said information to the broader market." Another user of crossing systems complained about "poor customer service across the board from pool providers."
Still another trader said it was paramount to maintain control on an order-by-order basis over what a dark pool does with a trader's flow. Several traders complained about the difficulty in accessing liquidity as a result of dark pool fragmentation, while others said they didn't want dark pools to link up because that potentially erases some of the darkness that makes ATSs attractive.
The most notable comment, however, was a pained cri de couer from one institutional trader (written in all caps): "Why did we just go through the time and expense of Reg NMS if the next step was to try to figure [out] a way to circumvent it? Where is the SEC now?" Presumably, that person was commenting on the lack of transparency about what firms do in the dark pool space. All trades that occur in dark pools execute within the national best bid and offer.
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