Transition managers seek dark pool trades

Michael Jackett-Simpson is watching for news that the stalemate between would-be merger partners, the $43 billion AustralianSuper and $4.6 billion AGEST Super, and the Australian Government will end.

Should Treasury allow the smaller fund to use $45 million in investment losses it accrued during the global financial crisis to offset future capital gains tax (CGT) liabilities, the final hurdle barring the merger will have fallen. More funds will be spurred to join and capitalise on the so-called CGT. Jackett-Simpson, the managing director of transition and pension services at Citi, and other transition managers will seek opportunities to help funds merge assets.

Whenever assets shift among institutional investors – when superannuation funds, for instance, change investment managers, buy and sell stocks to rebalance portfolios, or merge – they usually select a transition manager to move the assets. This involves transactions on “lit” trading venues, such as the Australian Stock Exchange (ASX) and Chi-X Australia, and off-market venues known as “dark pools”, where buyers and sellers anonymously trade large stock holdings. A transition manager’s access to stocks through dark and lit venues and their ability to transact at minimal cost are their chief competitive qualities.

Dappled fragmentation

Unlike Australia, developed markets such as the US, UK and Europe have harboured more than one major trading venue, or undergone market “fragmentation”, for over a decade.

Since Chi-X Australia began operating in October 2011, it has drawn about 1.5–2 per cent of trading volume. “It’s going to be a slow burn,” says Steve Hammerton, head of direct execution services at UBS in Australia, about the pace of market fragmentation in Australia. The most tangible effect of the end of the ASX’s monopoly is its reduction in trading costs and investment in technology.

Transition managers, having seen exchanges compete for trading volumes overseas, have changed their algorithmic trading systems to incorporate the new venue. Smartorder routing algorithms seek cheaper prices and greater stock volumes among dark and lit venues. The required technology is available. “It’s plug and play,” says Hammerton.

Dark pools, operated by large brokerages and other trading businesses, are fragmenting the Australian market and are being used more often by transition managers. More than 40 per cent of transitions involving Australian equities made by State Street Global Markets in 2011 were executed in dark pools.

These were big deals: more than half were orders exceeding 20 per cent of average daily traded volume in the securities concerned. “The volume and percentage of orders we’ve executed off-market has increased substantially,” says James Woodward, the Sydney head of transition management at State Street in Australia. The company uses its proprietary dark pool, fed by the approximate $400 billion in trading volumes sourced from more than 1000 transitions executed globally, and others, such as Liquidnet, which is exclusive to institutional investors, transition managers and custodians.

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