New crossing networks to meet growing demand
Isabelle Clary
Mar 9 2006
Crossing networks, the platforms where large orders hope to find their match without rocking stock prices, have gained such favor with the buy side that both US exchanges and prime brokers are readying various new offerings, industry sources said.
"A half-dozen crossing networks have plans to launch in the coming months, starting with Nasdaq," a senior executive at a prime broker told Financial News. "Liquidnet has shown how valuable the service can be. Demand on the buy side is only growing."
Portfolio managers, concerned about getting poor execution when exposing a large order to the marketplace, are increasingly favoring crossing networks' "dark books" that are not seen by the public and thus eliminate the risk of wide price swings.
The service is so valuable to the buy side that crossing networks can charge commissions eight times higher than the fees charged by ECNs and execution-only brokers. The buy side has seen those high charges worth every dime of it, because the overall transaction cost remains much lower than when large buy and sell orders result in sharp up or down price swings.
These alternative venues come in various models: negotiation between buy-side buyers and sellers on Liquidnet; auto-execution on Pipeline; or order matching at specific times on ITG's Posit or Instinet's CBX.
Exchanges cannot run "dark books" directly representing liquidity from the buy side due to regulatory considerations. But they can run crossing facilities where broker-dealers display large buy-side orders with certainty that a match will occur at the mid-point between the best bid and best offer.
According to another source, one regional exchange, which has recently received financial support from several brokerage firms, is readying a crossing network with enhanced features aimed at attracting the business of block-trading desks.
"It looks like a promising offering. Not all of the 'dark books' will succeed, but the demand for crossing networks is real," the source said.
Among the new comers on the exchange front, the Nasdaq Crossing Network is expected to kick off in the second quarter. It will allow large orders to be executed at a single price three times a day at 11:00, 13:00 and 15:00 eastern time, with a post-close cross at 16:30.
"Adding intra-day crosses is a natural evolution for the Nasdaq market," said Christopher Concannon, Nasdaq's executive vice president for transactions services, who added that the service will expand on Nasdaq's opening and closing crosses that have increased transparency and reduced volatility at two key points in the session.
"The difficulty in the marketplace is discovering liquidity. The intra-day crosses are designed to achieve this," Concannon also said.
In order to build a constitutency, Nasdaq Crossing Network will be free of charge for the first six months and later charge as little as $0.001 per share.
Finding deep pools of liquidity in the open market may also become more difficult when the Securities and Exchange Commission's Regulation NMS is implemented later this year. Reg NMS requires that all transactions be executed at the national best bid-offer (NBBO) across all markets, including exchanges and alternative venues.
Industry analysts believe that Reg NMS will actually entice the buy-side to look for a match away from exchanges' open books.
"Reg NMS will mean less liquidity," predicted Bernard Donefer, a fellow at the Center for Digital Economy Research at NYU Stern School of Business. He added that Reg NMS will only encourage institutions to trade on closed venues.
Other crossing networks in the works include several prime brokers' projects to transform their block-trading desks into electronic books so that the buy side no longer need to worry about the possible information leakage that occurs when the firm shops a large order around.
Speaking at the TradeTech USA forum this week in New York, Seth Merrin, CEO of sector leader Liquidnet, tied the surging interest in crossing networks to the increasing shift in the responsibility for achieving best execution from the sell side to the buy side.
"Today, the buy side and the sell side have the same tools to access liquidity. As a result, 70% of the buy-side volume bypasses trading desks," said Merrin, who added that, five years ago, 70% of the buy side volume was handled by brokers' block-trading desks.
The shift has resulted in a lack of information available to the sell side and curtailed their role, except for illiquid stocks that may require capital commitment from the brokers.
While no crossing network project is in the works at the New York Stock Exchange, where the average execution size is less than 400 shares, some industry participants speculate that NYSE Hybrid, which should get SEC approval in the near future, could morph into such a project. They noted that the Hybrid could be a destination for the reserves held by floor brokers' new interest files representing large buy-side orders.
The NYSE already runs an after-hour crossing network, the Off-Hours Trading Facility. Its parent, NYSE Group, started trading yesterday following its merger with Archipelago. |
