Dark Books: The Next Chapter
No One-Stop Shop
It seems there is a clear understanding in the buy-side-trader community that fragmentation is a persistent condition and that participation in numerous execution venues will be necessary until a volume leader presents itself. "I have never seen BIDS or LeveL, but I am open to the idea of dark pools," says Tim Olsen, senior vice president and head trader for ICM Asset Management in Spokane, Wash. "The market is so fragmented, I don't think any one destination will provide one-stop shopping for all my execution needs." Still, Olsen, who notes that he is a Liquidnet user but mainly uses ITG's services for seeking liquidity in dark pools, says he is concerned that ignoring new participants could mean missing out on high-quality executions. And, he has not determined that all destinations will be interconnected.
"What happens to our block flow if I am not in all these systems?" Olsen asks. "Do you have to use Pipeline directly? And if you use ITG to get to it, what are you missing?"
The idea of a dark-book aggregator, similar to the niche Lava Trading filled by aggregating ECNs in the 1990s, has its appeal, given the frustrating experience of managing multiple dark destinations with entirely different operating models. "We are always evaluating new entrants," says Jason Lenzo, head trader at Russell Investment Group in Tacoma, Wash. "These new systems may be cannibalizing each other because trading volumes overall are not corresponding to the growth rate of off-exchange trading. ... If they were to consolidate, they might reduce the cannibalization somewhat."
Scott Thornton, a managing director at TCW in Los Angeles, says that although he is investigating broker dark books, with some concern about anonymity, he mainly uses ITG's Posit. A user of Portware, he says he is confident that traders' desktop technology will overcome the fragmentation, creating a "virtual exchange" of sorts. "It's not that difficult for me to create an in-house ATS manager algorithm," Thornton contends. "I just sweep 100,000 shares into an ATS rules engine, delegate which ATSs to participate in, tell it whether to notify me when orders get hit, set price limits. ... Our traders can enter all that in." He points out there also are agency brokers and vendors, such as Instinet, that have developed algorithms that surf ATSs on behalf of buy siders; it seems likely BIDS and LeveL simply will become two more surfing destinations.
"Market fragmentation is of more concern to the exchanges than to us," Thornton says. "These microeconomics of cost - who charges 2.5 mils versus who charges 2.0 mils - are going to drive what this market looks like."
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