Agency broker Instinet became the third dark pool operator in Canada’s equities markets, when trading began on its two new venues in June in the small but growing niche of undisplayed liquidity.
The two new dark pools are Instinet’s first in the market and are designed to increase the level of block trading in Canada, said Peter Coffey, managing director at Instinet Canada Cross. The two new pools are also in compliance with Canadian regulators’ desire to foster block trading while at the same time providing users with price improvement.
To date, dark pools are not big in Canada. The only two in operation – Liquidnet and ITG – now both have U.S. origins. Given the trend in Canada toward increased use of algorithms, dark pools are seen as a natural development there. But some on the buyside are skeptical as to whether Instinet’s foray will increase dark pool volumes.
"Dark pools have not gained much traction in Canada so far, and will adding another change that? I don’t know," said Kelly Reynolds, director of trading at Toronto-based Hillsdale Investment Management. She is more inclined to wait and see how the pools’ details shake out before jumping in.
The first dark pool from Instinet is BLX, an algo-friendly venue that builds block trades by accumulating many smaller orders until a volume threshold is reached. It features several built-in "antigaming" features, such as volume triggers and a midpoint pricing window. The idea that HFTs will have trouble gaming her orders based on the uncertainty of the execution price, thanks to random execution within a 10-second pricing window, appeals to Reynolds-but this creates the same price uncertainty for her trades.
"The BLX crossing facility is a completely new concept in Canada and might gain some traction here," she said. "As an institutional trader, I have a lot of questions about how well this is going to work. But still, having a dark pool designed with antigaming features that are unappealing to the HFTs is a good thing for us."
BLX executes a trade at a random midpoint price generated from the orders within a 10-second window. HFTs will likely have trouble estimating just when the trade goes off, which is a plus for the buyside.
The second dark pool, VWAP cross, is nothing new, said Reynolds. Instinet’s iteration works by crossing orders each day at 9:15 a.m. Eastern and locks them in for the trading day. Trades are priced and printed after the market close, set for 4:15 p.m. Eastern, once the stock’s VWAP has been determined using the day’s data.
Doug Clark, managing director at ITG, which operates a rival dark pool, expressed concerns, saying the VWAP cross has limitations. "It’s a very tough sell to say to someone that when they enter into an all-day trading facility like that, they will not be able to get out when they want," he said.
He said VWAP cross strategies are always difficult and that traders are not able to place limit orders or volume constraints, such as limiting a trade to a percentage of daily volume, which can hurt the buyside. Last May’s "flash crash" exposed this very weakness of VWAP trades.
Instinet defended its product and the strategy, saying VWAP crosses work well in a low-volatility trading environment, akin to what the market is experiencing currently, where prices don’t vary much intraday.
Dark pool trading in Canada accounts for about 2.7 percent of the volume, or 634 million shares trade per day, according to research firm Forefactor.
"By the end of the year, I wouldn’t be surprised if Canadian dark pools’ share of daily trading volume rises to 5 percent of total market share," Clark said.
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