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June 18, 2012 | Volume 20 • Number 25 | www.mmexecutive.com | [email protected]
Large Blocks Dead? Not at Liquidnet
Venues
By Tom Steinert-Threlkeld
Y
es, Washington, D.C., there is a market where large
blocks of stock get traded. It’s called Liquidnet.
In April, the average trade size on this “dark pool’’ of
institutional orders was 43,309. And its participation
rate is high. Roughly 700 institutions with about $8.6
trillion worth of equities under management use the
network. These mutual funds, pension funds and other
asset managers execute big trades between themselves
or use the venue’s eight algorithms to execute transactions, even if they extend to other venues.
Compare that above-40,000 share average trade size to
the norm in other ‘’lit’’ and “dark’’ markets.
In so-called ‘lit’ markets for stocks, Nasdaq OMX
Group in late 2010 created a market that favored orders
of large size, over orders that arrive fast, called PSX, for
price-size exchange. CEO Robert Greifeld hailed this as
“a fundamental change to market structure.” But its goal,
even at the outset, was an average trade size of 500.
Then there are the ‘dark’ markets where participants
keep their names off their orders, presumably to make it
easier to trade with each other in larger blocks. More efficient, in theory. But the president of the keeper of dark
pool statistics, Joe Gawronski of Rosenblatt Securities,
declared the block dead in March. The average trade size
in dark pools had dropped 48% in the last two years. The
largest such pool, where firms exchanging shares stay
anonymous, is Credit Suisse’s Crossfinder. Its average
trade size in April? 174 shares.
The spread between Liquidnet and its closest competitor is huge. Number two amongst dark pools in average
trade size, according to Rosenblatt, is the Investment
Technology Group’s POSIT system. Its average trade in
April was 3,500 shares.
What’s Liquidnet’s secret? After all, technologically
speaking, it’s not that hard to set a floor on the trade
size in an exchange or trading system. Let each firm
simply mandate what size trade it’ll participate in. That
was Nasdaq PSX’s theory.
What appears to set Liquidnet apart instead is not
technology so much as who it allows to place buy and
sell orders into its pool of ‘liquidity,’ in the term of art
for capital markets.
The only organizations who can participate are mutual
funds, pension funds and other large financial institutions
who have natural interest in moving large blocks. Not
high-frequency traders, statistical arbitrageurs or, for that
matter, the “sell side.’’ The brokers and dealers whose jobs
are to create more trading and more trades.
“Our core business proposition is to match orders
between like-minded long-term investors,’’ said Lugene
Forte, Liquidnet’s Head of U.S. Equities.
On any given day, the asset managers Liquidnet
serves put in buy and sell orders involving about 1.8
billion shares a day in the U.S. and 10 billion worldwide.
Its ratio of buy orders to sell orders runs about 5050, which makes it easier to move large blocks. And, in a
seeming throwback to the days of ‘open outcry’ markets,
mutual funds and other institutions can negotiate the
final terms of a transaction, if they stay ‘’in the dark.’’
But they don’t have to. Liquidnet supplies “Stealth,”
Venues
Strategy
“Fair Market Value” and six other trading algorithms
that allow its institutional customers to execute large
block trades with “safe” liquidity from brokers and
outside venues while waiting for “natural liquidity”
to arrive at Liquidnet, from other institutions.
Traders decide how aggressively they want to trade
and what external venues they will or won’t trade in.
The algos also are designed to protect their identities,
as much as possible, wherever they are working on
institutions’ behalf.
To help make sure their customers don’t get ‘gamed’
or identified by potentially predatory trading firms,
the company polices all order flow that goes outside its
own bounds. A model for the ‘fair value’ of securities
underlies all portions of trades that end up in other
venues. Antigaming logic is written into every algo. The
company keeps a five-member Algorithmic Services
Group on alert throughout the trading day to watch
over the execution of its algos and spot any red flags.
The oversight doesn’t stop there. Seventeen relationship
managers actively watch over the trades of 400 institutional customers in the U.S. for problems. Twice that number,
35, watch for technical problems. To make the “crossing”
of large order work, worldwide, a lot of connections have
to be monitored, as do all the processes involved in settling
the trades.
A separate key advantage, Forte says, is that Liquidnet
is an agency-only broker. It has no skin in the game.
Other operators, such as Credit Suisse or Goldman Sachs
Group, have their own trading businesses to worry about.
At Liquidnet, mutual fund and pension plan managers
don’t have to worry about whether they are dealing with
a party who might trade against them, said Forte.
The firm is also trying to bring into play the kind of
services that have made public or ‘lit’ markets successful, as well. There is, for instance, the launch early last
year of a commission management suite of products
that does not just manage commissions.
Liquidnet’s program lets institutions set the terms—
say, how many pennies a share—go toward research.
And then carries out the instructions. Finding ways to
fund research when shares are being sold in 200-share
sizes at razor-thin margins is a corollary problem to the
speed versus size problem.
The company is, at the same time, trying to help institutions get their shot at shares in companies such as
Facebook or LinkedIn before they go public, and find
ways to work across both wholesale and retail markets,
as it did last year with the Swiss Securities Exchange.
The company’s model may keep it at the top of the
dark pool rankings in average trade size. But its overall
growth and health is not known.
The company prepared to offer its own shares to the
public in the middle of 2008. Then, the global credit
crisis hit. And it hasn’t tested the waters since.
And it might not have the “big block” market to itself
for that much longer.
A startup known as IEX Corporation has been raising capital and developing technology with the explicit
intent of creating a “safe” market for mutual funds to
trade in, in large transactions.
All launch processes are “in flight,’’ one person
close to the company confided. But how the company, led by former Royal Bank of Canada global head
of electronic sales and trading, Bradley Katsuyama,
will be an improvement over Liquidnet remains to
be seen.
MME
“That is the million-dollar question,’’ he said.
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