Pipeline ATS Shuts Off Access to Broker Algorithms

Pipeline Trading Systems LLC is cutting off access to third-party broker algorithms that are sending orders into the electronic block trading system it operates, according to an e-mail sent to clients this morning. The change in policy is effective next weekend, says the e-mail, which was sent to both buy- and sell-side clients.

In an interview on Monday with Wall Street & Technology, Fred Federspiel, president of Pipeline, says the brokers had problems with the large trade size that Pipeline insists upon, and second, they took issue with the prices that Pipeline charges for executing trades.The problem that the crossing networks face is that the broker algorithms are also seeking hidden liquidity in ECNs, which accept smaller orders and charge a fraction of the price. Orders in Pipeline for the typical stock have a 10,000-share minimum, while sizes can range up to 100,000 shares for very liquid names.

"They're competing with markets like Nasdaq and BATS Trading ECN, notes Jeromee Johnson, senior analyst at TABB Group. According to Pipeline's Federspiel, "ECNs are chasing down four billion share markets, and some charge much less than a tenth of penny per share, and some clients can pay one hundredth of a penny if you leverage in the liquidity and remove liquidity [rebate] fees."

However, Pipeline decided to stick with its large firm order commitment and price, says Federspiel. Because Pipeline decided not to lower its rate or trade size, from the end of last year until February of this year, Pipeline Block Market experienced a 63 percent drop in algorithmic volumes, while over the same time frame, Pipeline overall usage is up 10 percent, notes Federspiel.

He suspects that brokers put restrictions on letting their algorithms access Pipeline. In one case a top provider of algorithms into Pipeline cut off access to either Pipeline or a customer for three weeks, says Federspiel. In addition, algorithmic orders are fleeting as they dart in and out of Pipeline, which frustrates users reacting to orders that are no longer there, says the e-mail.

"It just became clear that this had too much potential for confusion," adds Federspiel. To eliminate the confusion, "We decided to eliminate third-party broker algorithmic access into Pipeline," he continues. Pipeline will still be accessible to the buy side via DMA platforms and directly through Pipeline, he says.

For example, brokers such as Banc of America Securities and Bank of New York (BNY ConvergEx Group) include Pipeline as a destination in their DMA platform, he notes. Under the new rules, Investment Technology Group's (ITG) DMA front-end Triton will be able to route orders directly into Pipeline via the FIX protocol, but ITG's Dark Server, an algorithm that hunts for hidden liquidity among multiple ATSs, will not be able to access Pipeline after Friday.

Meanwhile, ITG faces similar issues with broker algorithms accessing POSIT, the anonymous institutional crossing network for equities. Last year, ITG turned off access to Credit Suisse's gorilla algorithm when it learned that the broker was advertising to customers that it could access POSIT at a discounted rate.

"Credit Suisse was the only broker whose algorithm was accessing POSIT, and that was because we had a long-standing relationship with them and they were early to the game and had set that up a long time ago," explains Tony Huck, managing director of ITG. Though ITG discontinued the connection to Credit Suisse's algorithms, it continued the connection to the cash and portfolio desk.

In response, ITG reevaluated its policy on algorithms, but it did not ban algorithmic flow into POSIT. "We do have algorithmic flow coming into POSIT. We've introduced parameters for broker algorithms and are adding these algorithms at a measured pace," says Huck.

ITG introduced three parameters for algorithmic providers: First, brokers must charge the client a minimum price; second, brokers must know the client to make sure it is client algo flow as opposed to a portfolio desk or a cash desk; and third, periodically ITG conducts an audit to make sure that the broker algorithms are equitably representing orders in POSIT. This is to ensure that brokers "are just not using the good name of POSIT to advertise that they reach POSIT, but are actually submitting the orders," suggests Huck.

On the other hand, depending on the broker algorithms for flow can be risky. "If you are dependent on the brokers for your flow, they're going to price you at the lowest possible commission rate," says Larry Tabb, founder and CEO of TABB Group. "If a crossing network is dealing with 10 bulge bracket brokers, if any one of them decides to drop out, then 10 percent of your flow is gone," says Tabb. In addition, brokers have invested in dark pools such as BIDS Trading Service and LeveL that are built as utilities, says Tabb. "It's hard for a company [like a Pipeline and others] to make a profit at these price points," he says.

"From a business perspective, you really want to get closer to the buy-side trader because the commission compression is going to be a lot less," says Tabb. "The question from a liquidity standpoint is, 'Does this makes sense?' " says Tabb. On the minus side, cutting off access to the broker's algorithms removes liquidity. "The plus is there are people [institutions] that won't trade in your pool if you have algorithms in there," Tabb notes. "If the buy-side wants to put their blocks into an algo-free environment, then that's the positive. We'll see the results of that over time." 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