Several brokers are designing algorithms that sweep crossing networks and so-called dark books – liquidity pools that match buy and sell orders without publishing a quote. Similar to crossing networks, dark books are an alternative to the public equity markets that brokers are exploring for their algorithmic trades.
For example, in October, Piper Jaffray was set to launch Fusion, an algorithm that works within the public equity markets and simultaneously searches multiple crossing networks and dark books for hidden liquidity.
"We can either send larger orders to the block-crossing networks or send smaller orders to the dark books, and, in every case, we're searching for liquidity," says David Mortimer, head of product development, Piper Jaffray Algorithmic & Program Trading Group (APT). Mortimer explains that Piper is in a position to have relationships with large crossing networks because the broker represents institutional flow, as opposed to statistical arbitrage flow, and doesn't trade for its own proprietary account.
Additionally, in July, Investment Technology Group released Dark Server – an algorithm that scans multiple alternative trading systems (ATSs), including ITG's own POSIT, NYFIX Millennium and Pipeline Trading, simultaneously. "What all of our clients want to do is have access to a lot of the ATSs through one source," says Tony Huck, managing director at ITG. Further, institutions want to soak up as much natural liquidity as possible without leaving a footprint in the market, he adds.
Meanwhile, Credit Suisse First Boston has had the capability to scan multiple ATSs with its Guerilla algorithm for about a year and a half. Manny Santayana, managing director and head of advanced execution services sales and marketing, Americas, for CSFB, says Guerilla is a stealth algorithm that provides a trading solution for the small cap and mid cap environment.
"It hides in the electronic bushes, and it waits for liquidity to appear," Santayana describes. "When liquidity shows itself, the guerilla comes out firing orders into the electronic marketplace, taking out liquidity and capturing price improvement for you in small cap and mid cap names."
NYFIX Millennium, an ATS for listed stocks that is considered a dark book, has been providing liquidity to CSFB's Guerilla algorithm for almost 18 months and has integrated with ITG's Dark Server as well, according to Bob Gasser, CEO at NYFIX Millennium. In each case, NYFIX allows the brokers' algorithms to search its liquidity for the contra side of the trade; if no match is found, then the order is routed to the public equity markets for execution. NYFIX Millennium is in discussions with a number of firms, Gasser adds, and, by year-end, he expects NYFIX will add an additional three or four broker algorithms. "It's all about building a pool of liquidity," Gasser notes.
According to Brian Devereux, VP, sales, at Piper Jaffray's APT group, "The driving force [behind Fusion] is inevitably the customer." Piper Jaffray began to explore the use of dark books and crossing networks as sources for liquidity about eight months ago, following the acquisition of Vie Securities, a provider of algorithmic execution services, in the fourth quarter of 2004. Institutional clients were looking for a simple way to access liquidity, not only for block trades, but also for any of their child orders – smaller orders that have been sliced and diced by the algorithms – relates Devereux.
Piper Jaffray's Mortimer explains that institutions may not have access to small order pools, such as Lava Trading's Dark Book – a function of the Lava Trading network that detects reserve orders and attempts to match them internally before the orders are displayed on ECNs or exchanges. "Sometimes, we can find 20,000 to 40,000 shares hiding on these dark books," he relates.
Piper officials will not reveal which specific crossing networks and ATSs Fusion searches because they had to sign nondisclosure agreements. But the company acknowledges that currently there are four liquidity pools that let the broker algorithms sweep them – ITG POSIT, NYFIX Millennium, Pipeline Trading Systems and Lava Trading's Dark Book.
A fifth pool – Liquidnet, the electronic marketplace for institutional block trading – is not open to the sell side, relates NYFIX Millennium's Gasser, who questions whether that will change. In fact, on Sept. 21, Liquidnet's new version, [H.sub.2]0, began to admit streaming liquidity providers, including aggregators of order flow en route to ECNs and exchanges. (Editor's Note: For more on how Liquidnet is transforming the institutional marketplace, see WS&T's November cover story.) These ATSs – which allow both brokers and buy-side firms to participate – often are referred to as dark books because they do not publish a quote and are somewhat labor-intensive to access in parallel, explains Gasser.
Don't Be Afraid of the Dark
"The relevance of dark pools has increased," adds Gasser, noting that POSIT, Liquidnet and Pipeline collectively represent a good chunk of listed market share. "You have to be there at this point," asserts the CEO. While NYFIX Millennium currently specializes in listed stocks, it plans to introduce Nasdaq stocks by the end of the second quarter, Gasser adds.
One reason for the trend is that institutions have difficulty representing their orders in multiple crossing networks in parallel, according to Gabe Butler, VP, algorithmic trading, at ITG. "When you want to get an execution on an ATS, you have to commit your order," he explains. For example, if a trader wants to represent an order in POSIT, Pipeline and NYFIX Millennium, today the client would chop it up and put a piece in each venue. "But it's very labor-intensive and time-consuming," explains Butler.
Further, traders may post the order into each ATS in sequence, starting with POSIT, because it's the biggest liquidity pool, then go to Millennium and then Pipeline, Butler continues. But if they post their orders in each ATS sequentially – waiting to see if there is a match in one before posting in another – they might miss a potential fill in the others, he points out. "It's all about two ships passing in the night," Butler says.
With Dark Server, for example, ITG simultaneously and dynamically can split an order among all the ATSs at the same time – the algorithm reacts to changes in the marketplace automatically, Butler continues. It readjusts the order on POSIT if it gets fills in Millennium, for instance, or vice versa, he says.
One potential differentiator for ITG is that it owns POSIT, the largest liquidity pool among the four venues. "We're able to give people better execution than maybe our competitors will because we have no disincentive to access this pool because it's our pool," asserts Butler. Conversely, he says, competitors might "down weight" using POSIT because they would have to use ITG and pay 2 cents or 3 cents a share, which could create a money-losing proposition.
But, Piper's Mortimer says, Piper already is connected to and pings POSIT today. However, "For most [other] brokers, [ITG] is right," he concedes, noting that brokers take costs into account when they route orders to different ECNs and exchange venues. But, Mortimer adds, "We've made a determination that our customer's interest comes first among economics. We're willing to pay higher rates if that venue has sufficient liquidity."
Copyright (c) 2005 Gale Group Company
12/06/2005 09:46:16 PM [Wall Street & Technology]
