See Related Feature: Volatility Shakes Up Block Trading
Independent block crossing networks lost market share to dark pools owned by broker-dealers and market makers in 2008, according to market structure analysis by Rosenblatt Securities. While block venues steadily gained volume after the launch of Liquidnet in 2001 and through the introduction of Block Board by Pipeline Trading in 2004 as institutions sought to hide their intentions and avoid market impact, recent market volatility coupled with the rapid growth of algo-friendly broker-owned venues is driving a transformation in the dark pool space.
"The volatility does affect the way that dark pool volume is growing," explains Justin Schack, VP, market structure analysis, at Rosenblatt Securities. "Even though the market share of dark pools as a whole is rising, the extreme volatility is hurting volume growth for block-oriented venues." According to Schack, Rosenblatt began to notice the trend in summer 2008.
Dark pools owned by brokers and market makers increased their share of dark order volume to 64 percent in December 2008, from 58 percent in April 2008, Rosenblatt reports. The market share of the independent and agency dark pools -- including Liquidnet, ITG's POSIT, Pipeline and NYFIX Millennium -- fell to 14 percent as a group in December, from 24 percent in April. Meanwhile exchanges raised their share of the dark volume to 15 percent in December, from 10 percent in April, reflecting the success of Direct Edge's Enhanced Liquidity Provider Program, which solicits liquidity from and routes flow to dark pools. Though there are only two exchanges -- Direct Edge and ISE MidPoint Match -- included in this category, others such as NYSE Arca, Nasdaq and BATS began routing to dark pools and soliciting dark pool liquidity last year, so their volumes buoyed the growth of their dark pool partners as well.
"Most independent and block-oriented pools had a tough year in 2008," wrote Rosenblatt in a special year-in-review edition of its monthly dark pool liquidity tracker, "Let There Be Light," published on Jan. 29, 2009. Even as trading volumes skyrocketed amid intense market volatility, three of the four volume losers for the year come from the independent/agency category: From January 2008 to December 2008, Liquidnet's average daily volume fell 46 percent, NYFIX Millennium's volume dropped 39 percent and POSIT's volume slipped 28 percent, according to Rosenblatt's analysis. Rosenblatt numbers include Liquidnet's H20 volumes, single-counted, because they are executed within the Liquidnet system, but exclude any shares routed by Liquidnet for execution in the public markets. Supernatural executions, which comprise orders that interact with streaming liquidity from broker algorithms, typically account for 20 percent to 30 percent of Liquidnet's adjusted average daily volume, according to Rosenblatt's report. Two-thirds of the Supernatural/H20 flows are crossed within Liquidnet, while one-third is sent outbound, according to Vlad Khandros in Liquidnet's corporate strategy group.
Discussing Rosenblatt's findings with clients during a conference call in January, Schack noted that the steepest growth curves in the space correspond with algo-friendly small-size venues, such as GETCO Execution Services, Knight Link, Goldman's Sigma X, Credit Suisse's CrossFinder, Citi Match, and LeveL, which is owned by a consortium of big brokers. On the other hand, independent and agency pools that focus on block crossing show flat to negative growth on the year.
A major differentiator was order size, according to Schack. For example, Liquidnet's average execution size was more than 50,000 shares. "But the vast majority of the executions in dark pools today are for less than 400 shares," Schack told clients.
Ivy is Editor-at-Large for Advanced Trading and Wall Street & Technology. Ivy is responsible for writing in-depth feature articles, daily blogs and news articles with a focus on automated trading in the capital markets. As an industry expert, Ivy has reported on a myriad ... View Full Bio