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Having your cake and eating it

The FFI clearly shows that fragmentation is steadily rising as smart routers continue to spread trading volume across different venues. Looking at last week’s data, though, I couldn’t find a single venue (primary or MTF) that wasn’t showing a decline in its overall volume for the week. Obviously the bank holiday and half term break affected the figures but this still highlights the simple fact that the total quantity of order flow is substantially lower than it was in pre-credit crunch times. And, of course, there are more mouths to feed now that the primary venues have to share a table with the growing MTF community. No wonder, then, that so many venues are making a big play of their dark pools. Analysis of one stock – BMW – shows why.

The charts below show trading in BMW stock on 6th May 2009.

Firstly, the lit breakdown shows that, as expected, trading in BMW was primarily split between Xetra and Chi-X, followed by Turquoise, BATS and NEURO.

But, as can be seen below, almost half of the total volume didn’t even make it onto the lit order books.

This volume was broken down between bilateral OTC trading (shown in red), non broker owned dark pools (blue) and systematic internalisation within the broker dealer community (orange). While it’s true that these three categories represent “different” sorts of trading, they all went into baking the same cake (i.e. shares traded in BMW for the day in question). The main challenge for these dark pools will be grabbing market share. The question is, will it be at the expense of the OTC and SI players, or through the conversion of lit volume to dark.  

Related to this is the combined impact of MiFID and technology which is putting lit and dark venues on a collision course because, ultimately, both will feature in any best execution decision.  

When all possible (lit and dark) venues are considered for BMW then its FFI rises from 1.71 to 3.99 which highlights just what’s at stake. But, whichever way you look at it, venues may find that harnessing available dark liquidity is a better strategy than simply trying to take bites out of each other.

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