Wednesday, December 14, 2005

Tracking down liquidity not science fiction anymore

Gregory Crawford
28 November 2005
Pensions & Investments
Volume 33; Number 24
(c) 2005 Crain Communications, Inc. All rights reserved.

Some of their names sound like science fiction but the latest institutional trading products seek something very basic: helping money managers find liquidity wherever it exists - at exchanges, electronic communication networks or alternative trading systems.

DarkServer, from New York-based ITG Inc. was launched in mid-October, around the same time that Piper Jaffray & Co., Minneapolis, unveiled its new product, Fusion. Liquidnet Holdings Inc., New York, which developed a money manager-only liquidity pool, is rolling out its next-generation product, H20.

Each product is an attempt to solve an ongoing problem money managers have - buying or selling large blocks of stock with as little information leakage and market impact as possible.

DarkServer ``is a very logical extension of the business ITG has been in for a long time - taking care of the needs of institutional investors that are very concerned about information leakage and market impact,'' said Mark Wright, a managing director in charge of direct access and consulting services at ITG. DarkServer was officially launched on Oct. 11.

The product ``sweeps'' the marketplace to find pools of stock and then provides the institutional investor the opportunity to trade. Prior to DarkServer, ITG clients could only search through ITG's internal systems for liquidity.

Flexibility built into DarkServer allows the trader to offer some information on the trade to improve chances of getting the order filled.

Also searching

Piper Jaffray's Fusion is similar to DarkServer in searching the marketplace for liquidity.

``Fusion is the solution we developed for a specific client to help them solve the problem of disaggregated liquidity,'' said David Mortimer, head of product development, algorithmic and program trading at Piper Jaffray, referring to liquidity that's spread throughout the marketplace. That client's interest led Piper Jaffray officials to believe that interest would be widespread among all its clients, leading them to offer the product to everyone.

Fusion finds liquidity wherever it sits, pulls it together and allows a trader to get a trade completed, while maintaining the trader's anonymity and keeping market impact to a minimum.

In addition, Fusion allows the trader to set parameters for the trade such as minimum order size. Such constraints can help a trade that's tailored to unique specifications, Mr. Mortimer said.

He said Fusion was built - and connections to alternative trading systems made - with anonymity as a core feature, which traders say is paramount.

``Anonymity is premier in all these systems,'' said Ted Oberhaus, director of equity trading at Lord, Abbett & Co LLC, Jersey City, N.J.

He said he would not hesitate to stop using any electronic trading system if he had an indication that other participants were picking up information about his orders that was confidential.

Once information about an order is leaked into the marketplace, other investors will jump on it and play the other side, driving the price of stock away from the price at which the original investor wanted to trade.

``We're all paranoid,'' Mr. Oberhaus said.

Slow on H2O

At Liquidnet, executives have been slowly rolling out H20, the firm's new attempt to capture and offer more liquidity to its clients.

Through agreements with third-party retail order flow aggregators like ECNs, Liquidnet captures small retail orders and offers it to their own clients before the orders get sent into the public marketplace.

If a stock in the system has retail order flow, an institutional trader can set up some basic price and size parameters, turn on H20 and let the system fill the order with the smaller retail pieces. H20 works in conjunction with the traditional Liquidnet system so if a trader has a large order to fill, he or she can work it in the original Liquidnet system while also getting smaller fills through H20.

``We're solving a huge problem,'' said Seth Merrin, chief executive officer of Liquidnet. ``Institutional orders are way too large for public markets and it doesn't matter how you slice them.''

He said H20 seeks to balance the retail and institutional - what he called wholesale - marketplaces, where there is too much wholesale supply for retail orders. Rather than having institutions slice up their orders - a common practice among money managers who don't want to let the marketplace know how big their entire order is - H20 allows an institution to effectively bundle retail orders as they come in.

``You want the marketplace to reflect the demand and the direction that's out there,'' he said.

The systems are just the latest developments among brokerage firms - and some software vendors - attempting to offer managers the ability to use algorithms and other technology to increase trade efficiency, fill rates and ``sweep'' the market for liquidity.

For traders, the problem is too many systems offering solutions that are too similar.

``We get inundated with people wanting to show us their system,'' said Stephen Sachs, director of trading at Rydex Investments, Rockville, Md. ``Ultimately they're really all the same - just different ways of skinning the same cat.''

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