Interview with Chris Jenkins, managing director, Tora Trading Asia
What is toxicity and how is it measured?
Toxicity in trading terms is defined as the quality of executions in a trading venue. Toxicity analysis is a critical tool for shedding light on the value that an alternative liquidity pools can bring to the investment process. It is measured by comparing the price of executions achieved in a pool with executions occurring immediately before and after those in the primary market. Toxicity analysis and results are generally consistent across all timeframes.
While each pool has monthly variations in their toxicity levels, it’s clear which pools are consistently toxic or non-toxic. In short, some pools need to be watched more than others and only accessed in limited circumstances where getting liquidity is paramount.
Is toxicity an issue for the trading community in Asia?
Toxicity is a growing issue in Asia, given the increasing amount of venues and pools available. It is not necessarily a bad thing and just because traders cross with flow that is deemed to be toxic does not mean that traders are being gamed. As knowledge and trading expertise builds in Asia, so does the richness and depth of data to analyse alternative liquidity pool execution. Traders in Asia should have the ability to see if they are achieving best execution for their trades. Toxicity analysis is useful for helping the buy-side to make informed decisions on what they are trading. It is not often made publicly available, which creates a gap in understanding the true effectiveness of these pools in achieving best execution.
How can I protect myself from a toxic pool?
Firstly, traders need to understand which pools are toxic. Then the trader needs to work out their criteria for execution in these pools. Making use of the right tools can help them make informed decisions about whether they would like to remain part of the pool or opt out.
Many alternative liquidity pool operators segment, or tier, their flow based on counterparty type. An alternative to completely opting out of pools which are measured to be toxic is for traders to opt out of crossing with particular flows.
Toxicity should not be viewed as necessarily negative, traders may be content to be trading in a so-called toxic pool, so long as they have their orders filled in a timely manner where they would otherwise have difficulty getting filled in the primary market.
What tools do we need?
Toxicity analysis and understanding the factors that affect pool quality are used by TORA to make smart decisions on the operation and rules of engagement of its pool. Ultimately the aim of any off-exchange venue is price improvement, reduced market impact and liquidity.
Advanced smart routing technologies, such as TORA’s smart order router, TSOR™, are built to enable buy-side traders to source liquidity across multiple off-exchange venues. This includes toxicity-based rules to intelligently direct flow to quality pools and posting certain types of orders to pools where that order is likely to benefit. Even relatively toxic pools have a place especially when liquidity is thin or the most important criterion is executing the order.
One thing for certain is that alternative liquidity pools are here to stay. These venues will grow to be an even more important part of the process in enabling the buy-side to deliver price improvement and liquidity while protecting anonymity. Rather than shy away from accessing alternative liquidity, it is a matter of using analysis and liquidity tools smartly to aid execution decisions and empower the buy-side trader to make a positive impact on the bottom line.