With money management firms growing rapidly in size over the past 10 years, being able to trade large blocks of stock without any information leakage to the market is becoming a major issue. Such information leakage can wreak havoc with portfolio returns and execution costs by causing a negative market impact on the stock being traded.
Obviously, large money management firms such as Fidelity Investments like to find ways to control trading costs and trade large blocks of stock without these effects. Because average trade execution size has decreased in the cash equities market since decimalization and the commoditization of electronic communication networks (ECNs), institutional investors are looking for a quicker, more cost-effective means of pushing large blocks of stock and reducing their market impact costs.
Here is where large block crossing networks such as Liquidnet, ITG POSIT, Pipeline Trading Systems, NYFIX Millennium and Nasdaq Cross come into the picture. These trading systems have transformed the way traders seek liquidity and are putting pressure on the traditional trading venues such as the NYSE and Nasdaq, as well as sell-side trading desks.
A type of alternative trading system (ATS) - which also includes call markets, matching systems, crossing networks and electronic communication networks - block crossing networks are electronic systems that bring together potential buyers and sellers of securities to execute large blocks of securities (10,000 shares or more). By facilitating execution, they essentially disintermediate exchanges and challenge the agency brokerage trading model. Large block crossing systems are not new, but the buzz about these systems has recently heated up in the trading world.
The illustration below depicts how decimalization caused a decrease in trade size that led to the need for block crossing networks.
In order for the block crossing networks to gain more market share, they must improve execution rates. Obviously, more executions equal more trading, which in turn builds market share. But how can these systems improve their execution rates?
If most block trading systems are executing trades at a 6 percent rate, a slight increase in market share can happen only with a substantial increase in liquidity. These systems are most efficient when trade orders can be entered into the system and remain posted there for a period of time waiting for contra flow (the opposite side of a trade, whether buy or sell). But with so many trade orders from various sources passing through the system, chances are slim that two trades that are a likely match will happen to be passing through at the exact same moment.