The decline in bilateral voice OTC trading coincided with the rise of automated dark trading, enabling institutional traders to become more autonomous from brokers in their endeavors to maximize returns for investors. But with this autonomy comes responsibility. Buy-side traders have to ensure they are armed with the facts to ask the right questions of their broker s – and question the answers that they are given. As a result of the increased usage of FIX protocol tagging, venue analysis and TCA (Transaction Cost Analysis), buy-side firms in Europe can now obtain enhanced post-trade transparency to achieve this analysis. This analysishas been more prevalent in Europe than in the US for one clear reason: Reg NMS. Whereas in the US, venue selection was the responsibility of the broker, in Europe, the buy-side trader has had the ability to self-select the venue of choice for a number of years now.
[Related: “No, Michael Lewis, the US Equities Market Is Not Rigged”]
As retail investors continue to outsource their wealth to institutional managers through mutual funds and ETFs, the concentration in asset managers and resulting homogeneity in trading decisions, partly driven by benchmarking, will continue to result in fewer, but larger and more challenging, trades to be executed in an environment of declining turnover – overall European volumes in 2012/3 were roughly one-third of those in 2008. Thin volumes expose trading intent and impact performance. Hence, European buy-side traders will continue to push for greater knowledge of venue and broker behavior, as well as independently verify the answers they have been given.
This will be a dynamic process. Just as no two dark pools are the same, venue performance can fluctuate according to external market conditions as well as the individual order being executed. The underlying activity of individual pools needs to be understood and continually reassessed. Buy-side traders have to educate themselves as to what is happening, where. If the buy side abdicates measurement responsibility, it becomes much harder to take its claims of incredulity seriously– you can’t have your cake and eat it too.
Now thelatest accusations maynot relate per se to all dark poolsbut rather to the methods of disclosureof the US team of Barclays LX. Whether we agree with Mr. Schneiderman’s position,no buy-side tradershould be taking any brokers marketing material as fact-based evidence upon which to trade; but this will also depend on the full and accurate provision of full routing data by brokers. It is not only where a trade was filled, but where it was not filled that also provides the true picture of activity.
Only through greater education and the ability to independently verify a broker’sperformance will confidence rightly be restored tothe markets. As trading becomes further divorced from the research process and the buy side becomes more autonomous from the sell side, the requirement to demonstrate best execution will facilitate greater broker transparency as well as increasedknowledge and education on the buy side – and that can only be a good thing for the equities markets as a whole.