Independent Aggregation: An Oxymoron

Ah, to be an independent aggregator ... to develop ECN aggregation technology; provide quick and consistent order execution and blazing-fast market data; and get acquired by one of the world's largest brokerages for (I am guessing) gazillions of dollars - that's the life. It's even better than being an ECN - while most ECNs have come and gone, aggregators (or direct-access providers) are being acquired by the gaggle.

First, BankAmerica Securities acquired Direct Access Financial. Then, BNY Securities bought Sonic Trading. And, in July, Citigroup purchased the largest aggregator, Lava Trading. Even smaller players are being acquired: Penson Worldwide, a correspondent clearing firm, acquired Nexa Technologies in mid-July.

Clearly, brokers want to be in the aggregation business - desperately. But why?

Brokers need to be in the low-margin, high-velocity trading business - because it's the only business left. Blocks are dwindling as aggregation and algorithms are splitting large orders into smaller ones. Size is fragmenting and liquidity has all but vanished. The average U.S. Equity trade is now less than 440 shares (down from 1,400 shares in 1997) and NYSE program trading volume during May and June averaged over 55 percent, with the week of June 21 hitting 70.5 percent.

How will these acquisitions affect the client?

The acquisition of direct-access platforms means buy-side traders need to look for a new execution platform. While buy-side firms are consolidating their broker relationships, they don't want to use only one broker. They need multiple execution parties to diversify risk, get competitive pricing, acquire research, increase anonymity, tap differentiating trading skill sets and maintain interpersonal relationships.

Integrating multiple platforms is also not in the cards, as desktop real estate is scarce and picking multiple solutions, integrating them into the buy sides' order-management and portfolio-management solutions, and training the traders and support staff will be logistically and practically unpalatable. So, what's a buy-side firm to do?

There appears to be three options: switch to an independent platform, apply pressure on brokers to open their proprietary and acquired platforms to become multi-broker, or apply pressure on buy-side order-management-system providers to embed execution technology. But none of these solutions is perfect.

While migrating to an independent platform may be the most practical, it may be problematic. Choice is certainly more limited today and probably will be even more limited tomorrow. Since most of the firms in this space are start-ups, the chance of picking the one that will remain independent is certainly small.

Pressuring brokers to make platforms "multi-broker" may work, but it may not satisfy a buy-side firm's desire for anonymity, research and relationship. And buy-side order-management platforms - which were not developed to be execution platforms and may lack the capabilities to handle real-time trading, massive quantities of market data and the low-latency environment needed for aggregation - may fall short as independent trading platforms. That, however, does not preclude acquisition or partnership with an independent player.

Aggregation's time has come, but independent providers have gone. It is technology that the industry needs and brokers can't live without, but does the act of acquiring a platform devalue it? Can the segment ever get large enough to support a profitable technology company? If not, then how will buy-side firms adapt?

It certainly is an interesting problem - unless you're an aggregator. Then it's an interesting opportunity.

Larry Tabb is founder and CEO of Westborough, Mass-based The Tabb Group, a financial-markets strategic-advisory firm [email protected]