Stock investors who recognise the risks of trading in anonymous "dark pools" but are unwilling to spurn them have found an alternative: club together. A growing number of European investment funds have signed up to use an electronic trading system designed by one of their own - Finland's Pohjola Asset Management - which offers the ability to dissect and control the way their market bets are routed to dark pools and other exchanges across the region.
The data they generate is shared among the group, giving them strength in numbers but also leeway to change strategies.
This might seem like little more than back-office tinkering to the uninitiated - after all, fund managers are paid to decide which stocks to buy, not the minutiae of where to trade them. That job is usually left to brokers and banks, which often run their own dark pools while also offering access to rival venues.
But investors want more control and transparency over the trading process, fearing the post-crisis proliferation of opaque private markets and high-speed electronic traders has exposed them to new risks that can rack up costly losses.
These risks include a lack of disclosure about how some venues operate and price trades, as well as the danger that some give an unseen advantage to high-frequency traders.
"For many years, investment banks and other electronic brokers have provided electronic order-routing mechanisms ... But once an order goes behind a firewall it's very difficult to maintain total control over it," said Adam Conn, head of trading at Barings Asset Management, a user of the Pohjola router. "There is a growing empowerment within the buy side (investors) and that's a healthy development."
Enforcement actions against global banks that run dark pools have raised awareness of potential conflicts of interest. The UK's FCA markets watchdog warned in July that "many" banks and brokers were failing to put their clients' interests first when executing trades.
The implicit trading costs these risks represent may be just fractions of a percentage point on each trade, but for a fund turning over a $5 billion portfolio they could represent losses well into the millions. This is the kind of "slippage cost" Pohjola says it helps save.
Rather than try to outgun rivals with souped-up algorithms, Pohjola's system aims to reduce conflicts of interest by putting fund managers - not brokers - in charge of where to send trades. By comparing notes on each venue's performance, Pohjola and its clients make tweaks accordingly.
Designed by a team led by former Pohjola head trader Simo Puhakka, as well as ex-broker David Berney and electronic-trade specialist Keith Wright, the router is pitched as a bias-free and transparent alternative to putting trades in the hands of a broker who may have financial incentives to use certain venues.
"You can't rely on or trust solely what your broker delivers," said Puhakka in an interview. "We realised we should create a better solution, a better smart order router." Rather than build the technology from scratch, Puhakka partnered with data group LiquidMetrix and used execution infrastructure provided by agency broker ITG. Clients pay trading commissions as they would to any other regular broker. Three years after launching the system, with regulators scrutinising dark pools and the publication of Michael Lewis' "Flash Boys" keeping high-speed trading on policymakers' agenda, Puhakka has 20 clients using the system and meeting regularly to give feedback.
"The next logical step is that the buy side (investor) has to take control of the venues as well," he said, envisaging a new trading venue designed by the funds community. "The rule book would be written by the buy side ... We have had some discussions ... not just our group but a wider group."
Traders at three investment funds that use the Pohjola router - Barings Asset Management, Swedbank Robur and IPM in Stockholm - told Reuters control over trading was key.
"We think that Pohjola has a different approach, that they work for the client and that they can take away toxicity from different dark pools," said Swedbank Robur's Hans Lindh. While none of the traders said they would restrict themselves to only using the Pohjola router - some big block trades might for example fare better with a bank that has the balance sheet to directly take on the risk - they agreed that it was one way of independently getting more transparency and data.