Posted on 03/10/2008 2:49:07 AM PDT by TigerLikesRooster
Dark liquidity is on the starting blocks
Luke Jeffs
26 Feb 2008
Europe’s equity trading companies are gearing up for the increased use of dark liquidity pools, with rivals launching systems in the next weeks and months.
However, it is unclear if Europe, where dark pools handle less than 1% of trading, will mirror the adoption of these systems in the US, where they have about one-tenth of the market.
Dark liquidity pools, which enable buy-side and sell-side companies to trade blocks anonymously, thereby minimizing market impact, are the flavor of the month in Europe’s main equity markets.
ITG, an agency broker, is this week to launch Posit Alert, a service to enable fund managers to trade large blocks of European stocks, while Nyfix, a rival broker, is to launch its Euro-Millennium platform before the end of next month.
NYSE Euronext, the world’s largest stock exchange group, is to launch its dark liquidity service Project SmartPool before the end of June and Turquoise, the putative trading system backed by nine of the world’s largest investment banks, is making good progress toward the launch of its platform, which includes a dark liquidity pool, in September.
Liquidnet, the only block trading system live in Europe, continues to report its business is going from strength to strength, with participants and volumes up month on month.
Other vendors, including US incumbent Pipeline, which is rumored to be launching next year, are eyeing Europe as the next big market to undergo a dark liquidity revolution.
John Barker, managing director of Liquidnet Europe, said the demand for dark liquidity has increased as the value of institutional trading has increased in line with assets under management – he estimates it is up tenfold on 20 years ago – while the value of individual orders executed
on Europe’s stock markets has fallen.
Barker said Liquidnet was the first to spot the opportunity in Europe – launching in November 2002 – but there were challenges.
“First, centralized dealing was virtually unheard of and order management systems didn’t exist and second, there was a mindset that it was the broker’s responsibility to manage orders,” Barker said.
In recent years, however, these issues have disappeared and he said the business has enjoyed “strong growth.”
Barker added: “Others have seen our success and are preparing to launch their systems. But it’s all about liquidity and readily accessing it. You are more likely to exercise best execution in the larger liquidity pools than in systems that are trying to build up liquidity.”
He said that Liquidnet can press home its first mover advantage but welcomes the prospect of competition from new rivals.
Chris Smith, head of new business development for EuroMillennium at Nyfix International, agrees with Barker that the rise of dark pools, such as EuroMillennium, the Nyfix platform set for launch before the end of next month, is linked to trading performance on Europe’s stock exchanges.
He said: “The question is whether the established exchange public order books are suited to trading large blocks. Using the public books raises the chance they are advertising their intentions to the market.”
Smith argues that trading in the dark will emerge as another route to market, alongside algorithmic, computer-based execution and traditional, phone-based trading.
A factor in the rise of dark pools was the introduction of the European Commission’s Markets in Financial Instruments Directive four months ago.
Mifid made best execution law, a requirement that trading companies obtain the best deal for their customers, forcing fund managers and brokers to sign up to more execution venues, including the dark pools, to ensure they are compliant with the directive.
David Easthope, an analyst at financial markets research company Celent, said Mifid plays into the hands of these new companies but they should not expect to emulate, in the short term, the success they enjoyed in the US.
He said: “In Europe there is a lot of hidden liquidity traded on exchanges and issues around market impact and brokers trading ahead of fund managers are not as prevalent. European buy-side traders are happy to call brokers with large blocks and there aren’t the same complaints that we were hearing in the US before the independent dark pools emerged.”
Easthope provided four reasons why Europe will not follow the US example: the efficient order books offered by European exchanges; a lack of willingness on the buy side; the readiness of investment banks to provide capital to execute block trades; and the effectiveness of Iceberg orders that allow traders to hide their intentions while using exchange order books.
The Celent analyst agreed Mifid opens up opportunities in Europe but he said they will take time to materialize, leaving the door open to Europe’s largest exchanges.
He said: “Mifid will not be a Big Bang, rather it will be a slow burn. The exchanges know this and they are working out how they plan to address the increasing demand for trading in dark liquidity pools.”
NYSE Euronext was the first to declare its intentions, announcing in October a partnership with investment banks BNP Paribas and HSBC to create Project SmartPool and its plan to launch the dark pool before June 30 this year.
Virt-x, the European blue-chip stock market owned by the Swiss Exchange, followed in December, detailing its tie-up with Nyfix to deliver a block trading service for listed Swiss companies.
But Barker is not convinced the exchanges are suited to this type of trading. He said: “It will be difficult for the exchanges to get into this as their core function is price formation and they are dealing in retail size.
“It is natural they are trying to get this flow back but there is the added consideration of who is going to supply the complex trading systems to the buy side if the brokers are cut out and the managers are trading directly with exchange systems,” Barker added.
The 800-pound gorillas are investment banks, looking to compete with broker platforms from ITG, Liquidnet and Nyfix, and the exchange solutions with their dark liquidity pools. Citigroup, Credit Suisse, Goldman Sachs, Lehman Brothers, Morgan Stanley and UBS among others have internal crossing networks that they are rolling out to their European hedge fund, asset management and banking customers.
Their US market share, where they are well established, is hard to estimate because trades are matched privately and the banks are rightly secretive about their clients’ order flow but it is reasonable to assume they will be important players in Europe as well.
Industry observers say Easthope’s assertion that dark liquidity pools will have a harder time establishing themselves in Europe than they did in the US five years ago is a sound one.
Demand is unlikely to increase dramatically in the short term but, as Mifid starts to take effect in earnest in Europe, fund managers will be forced, at least, to connect to these systems. Until then the race among the brokers, exchanges and investment banks is on, say traders.
Ping!
I posted a reply to one of your posts last week, remarking on these “dark liquidity pools”. They have been ongoing in US markets for about 18 months now, but are starting to have some light shed on them. It’s a way to get around “open, free markets” and let the institutions scheme your average retail investor even more than they already do.
Sounds disturbing, but getting little press coverage.
Yeah, I’d say it’s disturbing. Let’s say you are interested in buying or selling XYZ Corp. at $50 per share. You now have no idea if institutional money is buying or selling at $45 or $50 or $55. I hate to sound conspiratorial, but you can probably bet that whatever trading they do on the openly quoted markets, NYSE or Nasdaq, is likely a head fake designed to screw over the little guy.
If they won't do it in the open, it is a conspiracy all right.:-) Not just a head fake but a flee flicker.
I FELL INTO A DARK LIQUIDITY POOL ONE NIGHT. Someone left the top off the Septic Tank.............
I remember seeing something about this in the U.S. markets a couple of months ago. It appears to me to be a scheme to trade under the radar, i.e., to give an advantage to Big Money that individual investors give up, rather than some kind of high-wire financial instrument of untested assumptions a la CDOs, credit swaps, etc.
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