NYSE and BIDS Trading Scan for Blocks in Light and Dark Pools Feb 03, 2009 URL: http://www.advancedtrading.com/showArticle.jhtml?articleID=213001260
A new block-trading venue launched by the New York Stock Exchange that links BIDS Trading's dark liquidity with the NYSE's public, reserve and hidden order flow could boost the Big Board's share of large orders.
But brokers and institutions still need to connect to the venue, New York Block Exchange, which launched Jan. 29. Further, they need to be assured that certain order types work on the venue, known as NYBX.
"You have to have a system up and running before you'll get a specific user to pay specific attention to your system," Tim Mahoney, CEO of BIDS Trading, tells Advanced Trading. (View AT's exclusive interview with Mahoney in which he shares details of the joint venture
Operated as a facility of the NYSE, NYBX is a joint venture between NYSE Euronext and BIDS Holdings, an alternative trading system (ATS) owned by 11 of the largest broker-dealers.
"The unique aspect of [the venture] is linking the exchange to an independent dark pool," says Larry Tabb, cofounder and CEO of TABB Group.
While a lot of dark pools are connected to each other, "The way they are connected here is a little bit different," he continues. "They're not trying just to match up dark flow. It's not all the algorithms linking the NYSE and BIDS together. It's not just the streaming order flow washing through BIDS' order book. ... This is a way to link together reserve flow and hidden order flow, which tends to be bigger flow."
The deal is also part of a push by the NYSE to bring back block trades to the exchange, Tabb adds. In the 1980s and '90s, block trades of more than 10,000 shares comprised more than 50 percent of the NYSE's volume. "They were matched upstairs and crossed on the floor," notes Tabb.
In recent years, however, as the average order size shrank to 200 shares, institutions have flocked to dark pools to seek anonymity and minimize the risk of moving the market. Today block trades comprise about 23 percent of the NYSE's volume, according to published reports.
Linking to BIDS' dark liquidity "is a way to increase the fill rates on the NYSE, encourage people to post more orders and to post larger orders, and also to create more block liquidity," says Joe Mecane, EVP for U.S. markets at NYSE Euronext.
One way in which NYBX is different from traditional dark pools is that "most dark pools are semi-insulated," Mecane says. "They tend to transact within their own pool, though there is some activity between then," he acknowledges.
"Second, they tend to be focused on the inside price and at the midpoint," Mecane adds. "Those two factors make it harder to actually line up the two sides of the trade."
Instead of executing trades at the midpoint or at the inside price, NYBX aggregates liquidity across multiple price points, Mecane continues, allowing interested parties to fill blocks across several price points.
For example, if there were an order to buy 20,000 shares at $10.02, and the NYSE has sell orders of 10,000 shares at $10 and another 10,000 at $10.02, NYBX would aggregate the two sell orders in order to fill the buy order, Mecane explains. However, NYBX would need to fulfill its obligations under Reg NMS first, he stresses, meaning NYBX must take out the best prices available on other exchanges before it can print at any price level outside of the prevailing market price.
BIDS Trading's Mahoney says people should think of NYBX as a middleman or aggregator between either BIDS orders or NYBX orders and NYSE liquidity. "It's a fully electronic mechanism that keeps track of the liquidity that's available in both venues and decides when a stock should be traded," he explains.
BIDS is open to all broker-dealers, investment managers, hedge funds and algorithms, and it provides access to NYBX liquidity by allowing subscribers to opt-in on an order-by-order basis. But while BIDS was set up to be very block"oriented, according to TABB, the majority of the flow became algorithmic. "They're trying to get back to the block focus," the analyst says.
According to BIDS' Mahoney, a former buy-side trader, the idea behind linking BIDS' liquidity with the NYSE's liquidity is to serve the portfolio manager, whose goal is to outperform the market or peers. Often, he suggests, a portfolio manager's strategy requires trading millions of shares of a particular stock. "If the average trade size is 200 shares, it's very hard to act quickly and take advantage of an opportunity in the public market," Mahoney says.
The industry's response has been to create dark pools to minimize the market impact of such larger trades. But while there are more than 40 dark pools, they account for only 9 percent of trading volume. While the idea of controlling information is critical, agrees Mahoney, he suggests that what has been missing is the ability of the floor brokers to expose their reserve orders to the public market.
According to Tabb, the NYSE is trying to get the floor back into the business of matching trades. "The liquidity on the floor has been fairly block-oriented. The problem is because most of the flow now is algorithmic, they can't interact with the stuff," he says. "So the floor brokers have to put orders into reserve and use algorithms. They wind up getting lots of little fills, and they're not as effective as if they traded larger blocks."
"They're trying to make the floor more relevant," Tabb continues. "They're trying to reconstitute the block business on the floor of the exchange. And in this environment, folks are looking for ways to reconstitute order flow. Now whether the genie is out of the bottle and algorithms will completely eliminate the desire for any type of block" is yet to be seen. "The question," Tabb says, "is, 'Will it succeed?' and I think we'll know that in a couple of months."
In a conference call reviewing dark pool trends in 2008, Joe Gawronski, president and COO of Rosenblatt Securities, an institutional broker-dealer that is an NYSE member, noted that exchanges are interacting more with dark pools and he expects this trend to continue in 2009.
"A particularly intriguing example of this convergence is the New York Block Exchange," said Gawronski, noting that NYBX integrates its own block orders with the public and reserve order books of the NYSE. "It's the first time anyone has delivered on the powerful concept of marrying block discovery with a primary market that discovers prices rather than executing everything at the midpoint of the NBBO." Gawronski added that NYBX merits watching in 2009.