Related Article: Volatility Shakes Up Block Trading
Several agency brokers say they are seeing growth in their block trading activity from institutions that are outsourcing order flow to their sales traders.
"In the fourth quarter of 2008, with the volatility reaching unprecedented heights, the sales trader became more important," comments Jim Morrow, COO at Capital Institutional Services (CAPIS), an institutional agency broker in Dallas. "When volatility picks up and [buy-side institutions] need to get an order done more quickly, they use the sales traders more," he explains, noting that CAPIS saw both an uptick in block activity as well as an increase in the average order size placed with the firm.
Although institutions traded fewer blocks overall in the fourth quarter of 2008, Morrow says, they still want to move blocks. And while block trading had begun to decline slowly in prior years, "For 2008 it actually went up for us," he adds.
"With all the volatility in the past six months, we're seeing a lot of volume go into the sales traders," confirms Anthony Conroy, managing director and head trader at BNY ConvergEx Group in New York. "That's why we're seeing the big prints." Conroy notes that BNY ConvergEx has been one of the top two liquidity providers on the NYSE for the past two months.
More Ways Than One to Execute a Block
According to CAPIS' Morrow, clients provide sales traders with instructions on how to execute blocks, taking into consideration the timing of an execution and possible market impact. "The sales trader is looking for natural crosses -- for buyers and sellers among mutual funds and investment managers. That is a little more difficult than it used to be because people are less willing to show their hands," he says. "If they want it done quickly, then it's a combination of going to an ECN or to the NYSE and going out to algorithms and then pinging the dark pools and doing it all."
But when the buy side hands an order to a sales trader, "There will be some market impact if there is a threshold for some tolerance to get it done at the trader's discretion," according to Larry Tabb, founder and CEO of TABB Group. "The trader will either look for the other side of the transaction, or they might just end up using an algo or a DMA tool themselves."
Amid recent market volatility, however, which has led to huge intraday point swings, algorithms have been less effective, CAPIS' Morrow says, noting that clients that wanted to trade a certain percentage of the volume often were chasing the market. "It was better to use a trader who would decide to get a block done and pay up to get liquidity or to pull back and wait," he asserts, adding that some clients are willing to pay up to execute a large block. "If they think that executing 50 1,000-share orders is going to move the stock more than executing 50,000 shares, they may be willing to pay 20 cents more for the trade," Morrow comments.
BNY ConvergEx's Conroy suggests the sales trader's role has evolved into a hybrid between human oversight and technology. "When you have that human oversight, then it's our job to pay attention to the dark pools and the algos and try to cross as much as possible," he says. On the other hand, Conroy adds, an algo doesn't take into account an unexpected news event (an earnings release in the sector, for example) that a sales trader can extrapolate to determine its potential effect on the stock.
"Every trade is different -- there's a different solution for every trade that comes in," says Conroy, who employs a strong technology platform in Eze Castle and 30 professional sales traders whom he refers to as "skilled surgeons."
"A lot of people want someone watching out for them and being their advocate on every trade," says Conroy, noting the historic volatility and dramatic change in the markets in the past six months. "That's why our business is up."