Recently launched investigations into dark pools in the US and regulatory proposals in Hong Kong to shed more light on how such trading venues operate have prompted investors to question how they use them.
There are others, though, that are becoming more receptive to the idea of employing these platforms.
Top of some long-only fund managers’ list of concerns is aggressive orders, which are often associated with high-frequency trading (HFT). The strategy relies on computer algorithms to make orders and generate profit from small price movements.
Buy-side players are becoming more curious about whom they are crossing trades with in these venues, which enable participants to purchase and sell equities anonymously.
One head trader in Singapore said his firm has had second thoughts about using the dark pools of brokers associated with the investigations in the US. “While clients have not asked us to avoid certain brokers, we are asking ourselves whether we want to be associated with houses that have issues,” he said.
Judging the merits of using dark pools by who is using them is tricky because there are no widely agreed standards, said Hani Shalabi, Asia-Pacific head of Credit Suisse’s advanced execution services division.
“There is no industry yardstick to measure a participant’s performance in a venue or the toxicity of a particular trading venue,” he noted.
One way of assessing the potential 'toxicity' of dark pools is whether one user is consistently achieving performance gains over others.
Admittedly, users of dark pools can request that their trades do not allow high-frequency traders, but it is not always clear whether the proper safeguards are in place.
In June, New York attorney general Eric Schneiderman sued Barclays, alleging it had misled its clients about the prevalence of HFT in its Barclays LX dark pool. The bank has denied the allegation.
Last month, UBS said its off-exchange trading venue was being investigated by the US's Securities and Exchange Commission, and Deutsche Bank said it had been asked by authorities to hand over information on HFT activities.
“We do not cross with high-frequency strategies, and we trust our brokers that they would not be misled into crossing with them, because once we lose our trust in our brokers, they are finished,” the Singapore-based trader said.
He argued that improving the transparency of electronic trading and dark pools should be the responsibility of both buy-side traders and sell-side brokers.
Shalabi said: "Investors who do not see the benefits of crossing in a particular venue will simply decide to trade in another in a market where competition is already stiff.”
Following a consultation process that ended in April, Hong Kong's Securities and Futures Commission (SFC) is reviewing rules to tighten rules covering dark pools.
Proposals include requiring dark pool operators to reveal the restrictions they place on users, how orders are routed, their execution methodology and proprietary order transactions.
That said, some managers are becoming more receptive to dark pools. The prospect of improved transparency has prompted US fund house Invesco to review several dark pools with a view to making use of such venues after the end of this year, said Stanley Luk, head of trading for Asia Pacific.
“In the past, we had more issues with whether clients’ order flows could be disadvantaged by the broker’s own proprietary trading flows, or the quality of the participants in a broker’s dark pool,” he said. Currently, in Hong Kong Invesco only uses Liquidnet’s institutional crossing network.
Dark pools account for only 2% of stock market turnover in Hong Kong, according to the SFC. In the US, alternative trading venues account for an estimated 12-15% of total equity turnover.