Big Traders Dive Into Dark Pools

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Looking at Liquidnet

On average, Liquidnet charges customers 2¢ per share, with no volume discounts. Given that the average trade size on Liquidnet is 52,000 shares, that's a bargain, says Eskandar. Commissions are the same at Pipeline and ITG POSIT, one of the first crossing networks, whereas BIDS (Block Interest Discovery Service) charges half a penny per share, the Aite report said.

Liquidnet operates by embedding its software into institutional investors' desk-top order management systems. The software essentially scans a customer's electronic trading blotter for buy or sell orders, which then pop up on the Liquidnet screens only of other customers whose blotters have comparably sized opposing-side orders of the same stocks.

"We're not soliciting merchandise that [institutional investors] are not interested in, so there's no noise," Eskandar says. "We're simply giving information based on the information they share."

NYSE Acquisitions

The growing use of alternative platforms has traditional exchanges scrambling to come up with ways to preserve their market share.

In the past year and a half, the NYSE has snapped up Archipelago, an ECN, and converted it into its electronic Arca exchange. It has also merged with Euronext, a European exchange, enabling NYSE members to trade foreign stocks. In addition, it bought a 5% stake in India's National Stock Exchange and has entered into a strategic alliance with the Tokyo Stock Exchange.

Yet, even as it expands into other markets, the Big Board is closing two of its four remaining physical trading rooms by November, and increasing rebates to traders who post bids or offers on the Arca system by 25% in an effort to protect its piece of the equity-trading pie.

Matchpoint's Moves

Its biggest move to stem the tide of trading volume to other venues may be MatchPoint, its own crossing system for big-block trades, which it plans to roll out in October or November, pending approval from the SEC.

Instead of the continuous crossing that most ATSs provide, MatchPoint will offer a series of scheduled crossing sessions, probably every hour on the hour during the regular trading day.

Jim Ross, who created MatchPoint and developed many crossing features at Instinet during the 14 years he worked there, believes that by amassing liquidity over time, the NYSE will be able to accommodate bigger blocks than a single-point continuous crossing system. While orders accumulate, all information is hidden and there's no interaction between participants, but users are able to edit, cancel, or add orders to the system. Orders become firm at the appointed match time and are matched on a pro-rated basis according to size using a national-best-bid-and-offer price derived from an external data provider.

A new securities regulation known as Reg NMS has leveled the playing field by requiring that all trading venues ensure the best execution of trades. The changes, which went into effect in December, 2006, were a catalyst for the formation of more of these alternative venues, which recognized that orders would find them as long as they could compete on price, says Bill Cline, chief executive of Acai Solutions, a capital markets consultancy in New York.

"Anyone who thinks [ATSs aren't] a threat to traditional exchanges' volume in cash equities is probably wrong," Cline adds.

Preventing Information Leaks

Driving investors' quest for greater anonymity and lower market impact costs are their well-founded fears that information was leaking whenever they placed orders with sell-side brokers, which prevented them from getting the best execution on their trades, says Cline. That's why Liquidnet remains essentially a club for buy-side investors only. And even if its H20 model lets in selected sell-side brokers, it's only to add liquidity to the pool for its buy-side members, not to give sell-side participants equal access to buy-side order flow.

Victory Capital Management in Cleveland has been using Liquidnet to execute large stock orders for the past two years. For Greg River, head of equities trading, the lack of information leakage is critical.

"We're large enough and a few of our specific investment strategies are that significant that when we do something it's visible, and people can [use it to] act against us," River says. "[Liquidnet] is a tool that allows us to trade and gets things done without revealing everything to every player out there."