Dark pools and best execution
On the anniversary of the launch of Turquoise Block Discovery™, Robert Barnes, CEO of Turquoise, the European multilateral trading facility, reviews empirical evidence of the innovation shaped by asset managers and brokers to answer the call for electronic block trading in a fragmented European landscape.
With the average trade size of exchange order books in Europe standing at around €10,000, investors wishing to trade much larger sizes are calling for innovation in electronic block trading (See ref. 1). In addition to sourcing block liquidity, benefits include minimising pre-trade signalling risk, cost efficiencies via straight through processing, and compliance with regulations including simultaneous real time post-trade reporting.
Asset managers, like BlackRock (See refs. 2-9), Fidelity (See ref. 10) and Norges Bank Investment Management(See refs. 11-15), among others, are increasingly vocal in published viewpoints about the role of exchanges in well-functioning markets and the benefits of execution choice.
Using a series of case studies, this article presents real world results of Turquoise Block Discovery™, a service shaped by asset managers and brokers matching undisclosed block indications that execute in Turquoise Uncross™.
Turquoise Uncross™ is an innovation, rebranded in October 2013, that allows buyers and sellers to rest firm orders anonymously, with size priority and potential to match at the midpoint of the primary market best bid and offer (PBBO), at a time determined by a randomised function. This key feature of auction-like randomised uncrossings makes Turquoise Uncross™ ideal for larger and less time sensitive passive orders (See refs. 16-17).
LiquidMetrix, the independent analytics firm that specialises in venue performance metrics and execution quality analysis “reviewed a large number of transactions on Turquoise Uncross™ and found that trades occurring on Turquoise Uncross™ had a far lower correlation with sharp market movements on primary venues than trades occurring on other continuously matched MTF dark pools. This means that from an execution point of view, large orders left resting on Turquoise Uncross™ are likely to be far less susceptible to gaming or adverse selection than orders left on other continuously matching MTF Dark pools.” (See ref. 18)
Alongside Turquoise Uncross™ and with input and support from a wide spectrum of brokers (See refs. 19-21) and asset managers (See refs. 22-25), Turquoise launched Turquoise Block Discovery™ in October 2014 (See refs. 26-28).
The following intraday case studies show prices on the y-axis and times on the x-axis. Bubbles reflect sizes of each order book trade and venue by colours: light blue = Turquoise Lit, deep blue = Turquoise Midpoint Dark, grey = all other external lit and dark venues that list or admit to trading a particular stock.
Blue chip: Imperial Tobacco (Figure 1a)
In aggregate, UK stocks trade more value by external dark venues than those of any other European country.
Turquoise Block Discovery™ Block Indications are undisclosed and match in Turquoise Uncross™.
Turquoise Block Discovery™ facilitated the largest order book trades for this UK blue chip of all order book venues, lit and dark, during this day. These largest trades match in Turquoise Uncross™.
These largest trades matched inside the lit order book tick size, so both buyer and seller also achieved price improvement by matching at the Turquoise Uncross™ mid price. All Turquoise trades report with real time transparency, and are MiFID compliant.
While dark order books do not show price and size before a trade, in an automated world, post-trade transparency contributes to pre-trade transparency for the next trade. Turquoise Midpoint dark order book trades, including those matched in Turquoise Uncross™, are published to the market in real time, with no delay, enabling all the benefits of straight through processing, and compliance with trade reporting of trades matched on lit order books.
Blue chip: Imperial Tobacco (enlarged view – Figure 1b)
Turquoise Block Discovery™ facilitates trades in Turquoise Uncross™ that trade inside the minimum tick, and in significantly larger size than the average European order book trade size of E10,000 (= E0.01m per trade).
Tick size refers to the minimum price increment that prices can move in the lit order book. This figure shows Turquoise Uncross™ trades that provide price improvement by matching inside the tick size of the lit orderbook minimum tick size price levels.
Post-trade costs often relate to the number of trades. Consider the €1.5m trade, successfully matched by a member in Turquoise Uncross™ in this example. €1.5m is 150x larger than the average European order book trade size of €0.01m. The €3.3m trade is 330x larger than the average European order book trade size.
The insight from this is that Turquoise trades at a size of E1m or more will save ~100x or more in post-trade clearing costs compared to an average dark pool trade size of €10,000, where clearing costs relate directly to the number of trades.
Less liquid stock: Jardine Lloyd Thompson (Figure 2)
This case study was presented to Turquoise by a buyside dealer highlighting a successful strategy in sourcing and matching a less liquid security. Understanding that trading a size of approximately 1 x average daily value (ADV) can take time and face potential adverse selection, the dealer rested anonymously and undisclosed as a Block Indication in Turquoise Block Discovery™. The dealer used his Execution Management System (EMS) to access his choice of sellside broker algorithm, designed as a direct channel to Turquoise Block Discovery™.
Notice the small size of infrequent trades that characterise normal order book trading of this stock. On the day of this example, the total traded value by Turquoise was more than 74% of all value traded on all order books, lit and dark.
While value traded in the Turquoise Uncross™ midpoint dark order book trades are large for this stock, the dealer emphasised the reason for presenting this example as successful, was to highlight that the undisclosed block indication was resting in Turquoise not for 90 seconds, nor for one hour, but for four days. And this was without information leakage, referencing benchmark metrics used by the dealer to evaluate execution quality (See ref. 29).
Therefore, the buyside dealer, while exercising more control over the order, continued to use his chosen sellside broker to direct the order to Turquoise, to benefit from the broker’s services including management of settlement allocation, and pay commission to the buyside dealer’s choice of broker.
Less liquid stock: Hexagon (Figure 3)
This example was presented to Turquoise by another buyside dealer highlighting a successful strategy in sourcing and matching large order book trades in a less liquid, Nordic security.
Turquoise Block Discovery™ facilitated the largest order book trades of all venues during this day. These largest trades match in Turquoise Uncross™. The large €5.7m trade matched inside the lit order book tick size of 0.1 SEK, so both buyer and seller achieved price improvement by matching at Turquoise Uncross™ mid price, and this trade size represented 2246% of the ESMA large in scale (LIS) threshold for this stock.
Why do LIS thresholds matter? Because they relate to MiFID II double volume caps.
MiFID II double cap calculations start in January 2016, building to 12 month rolling averages. MiFID II double caps will be effective from January 2017. MiFID II double caps could prevent a stock trading for six months via a relevant dark mechanism in sizes below the LIS. MiFID II double caps can prevent investors realising the benefits of such trading.
Currently, ESMA defines LIS thresholds per stock, based on a range of average daily trading values. For example, there is a greater LIS threshold for blue chip shares that trade over 50 million a day compared with micro-caps that may match less than 500 thousand a day. MiFID II will create more granular bands compared to MiFID I.
The potential salvation is the LIS waiver in MiFIR Article 4(1)(c), which allows authorities to allow dark trading for orders received by a venue that are LIS compared with normal market size and not include them in the double volume cap calculations.
In the next issue, we shall explore how investors and market participants should address these impending challenges.
 Barnes Robert. “Dark Pools and Best Execution” Best Execution Magazine, Summer 2015, pages 79-81. https://www.bestexecution.net/analysis-dark-pools-best-execution/
 Novick Barbara, Prager Richie, de Jesus Hubert, VedBrat Supurna, Medero Joanne. “US Equity Market Structure: An Investor Perspective” BlackRock Viewpoint, April 2014. https://www.blackrock.com/corporate/en-gb/literature/whitepaper/viewpoint-us-equity-market-structure-april-2014.pdf
 Novick Barbara, Goldstein Rob, Nair Sudhir, Tevet Shirlee. “The Role of Technology Within Asset Management” BlackRock Viewpoint, August 2014. https://www.blackrock.com/corporate/en-gb/literature/whitepaper/viewpoint-asset-management-technology-aug-2014.pdf
 Novick Barbara, Prager Richie, VedBrat Supurna, Riaz Kashif, Medero Joanne, Rosenblum Alexis. “Corporate Bond Market Structure: The Time For Reform is Now” BlackRock Viewpoint, September 2014. https://www.blackrock.com/corporate/en-ae/literature/whitepaper/viewpoint-corporate-bond-market-structure-september-2014.pdf
 “The European Capital Markets Union: An Investor Perspective” BlackRock Viewpoint, February 2015. https://www.blackrock.com/corporate/en-gb/literature/whitepaper/viewpoint-cmu-investor-perspective-february-2015.pdf
 “Securities Lending: The Facts” BlackRock Viewpoint, May 2015. https://www.blackrock.com/corporate/en-gb/literature/whitepaper/viewpoint-securities-lending-the-facts-may-2015.pdf
 Novick Barbara, Golub Ben, Prager Richie, Walters Kristen, Riaz Kashif, Rosenblum Alexis. “Addressing Market Liquidity” BlackRock Viewpoint, July 2015. https://www.blackrock.com/corporate/en-gb/literature/whitepaper/viewpoint-addressing-market-liquidity-july-2015.pdf
 Novick Barbara, Wiedman Mark, Prager Richie, Madhaven Ananth, Fisher Stephen, Shapiro Ira. “Bond ETFs: Benefits, Challenges, Opportunities” BlackRock Viewpoint, July 2015. https://www.blackrock.com/corporate/en-gb/literature/whitepaper/viewpoint-bond-etfs-benefits-challenges-opportunities-july-2015.pdf
 “BlackRock Worldwide Leader in Asset and Risk Management” BlackRock Viewpoint, August 2015. https://www.blackrock.com/corporate/en-gb/literature/whitepaper/viewpoint-blackrock-worldwide-leader-in-asset-management.pdf
 “Modern Markets: benefits and challenges” Fidelity Viewpoints, 2 February 2015. https://www.fidelity.com/viewpoints/investing-ideas/modern_markets_benefits_and_challenges
 “Well-functioning financial markets” NBIM Discussion Note, November 2012. https://www.nbim.no/globalassets/documents/dicussion-paper/2012/discussionnote_13.pdf
 “High Frequency Trading – An Asset Manager’s Perspective” NBIM Discussion Note, August 2013. https://www.nbim.no/globalassets/documents/dicussion-paper/2013/discussionnote_1-13.pdf
 “Sourcing liquidity in fragmented markets” NBIM Asset Management Perspective, April 2015. https://www.nbim.no/contentassets/1b25761cb30e4025b627865627610dab/asset-manager-perspective_1-15.pdf
 Shanke Øyvind G. and Emrich Simon “Trading in Dark Pools – An Asset Manager’s Perspective” Global Trading Magazine, 18 April 2015. https://fixglobal.com/home/trading-in-dark-pools-an-asset-managers-perspective/
 “Role of Exchanges in Well-Functioning Markets” NBIM Asset Management Perspective, August 2015. https://www.nbim.no/contentassets/03b3c386e08a4b59ba24bfc7d44d77e1/asset-manager-perspective-2-15.pdf
 Communications with authors, Dr Sabine Toulson & Dr Darren Toulson: “After 500 milliseconds following a continuous dark order book execution the PBBO mid changed approximately 50% of occasions, compared to less than 10% of occasions following a Turquoise Uncross™ execution. Also, the proportion of Turquoise Uncross™ trades executing outside of the prevailing EBBO is lower than continuous dark order book trades.”
 Stafford Philip. “Turquoise aims to lure institutions’ block trades to dark pool” Financial Times, 20 October 2014. https://www.ft.com/cms/s/0/88294b24-585a-11e4-b331-00144feab7de.html#axzz3nuAYvXlY
 Laurent Lionel and Hutchison Clare.”Fund managers push for safer trading waters in dark pools” Reuters, 21 Oct 2014. https://uk.reuters.com/article/2014/10/21/us-dark-pools-funds-idUKKCN0IA0S220141021
 Cooper James. “Disintermediation? Don’t Bank On It” Global Trading, 29 March 2015. https://fixglobal.com/home/disintermediation-dont-bank-on-it/
 Communication with dealer.