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Large Blocks Dead? Not at Liquidnet

Yes, Washington, D.C., there is a market where large blocks of stock get traded. It's called Liquidnet.

In April, the average trade size on this "dark pool'' of institutional orders was 43,309. And its participation rate is high. Roughly 700 institutions with about $8.6 trillion worth of equities under management use the network. These mutual funds, pension funds and other asset managers execute big trades between themselves or use the venue's eight algorithms to execute transactions, even if they extend to other venues.

Compare that above-40,000 share average trade size to the norm in other ''lit'' and "dark'' markets.

In so-called 'lit' markets for stocks, Nasdaq OMX Group in late 2010 created a market that favored orders of large size, over orders that arrive fast, called PSX, for price-size exchange. CEO Robert Greifeld hailed this as "a fundamental change to market structure." But its goal, even at the outset, was an average trade size of 500.

Then there are the 'dark' markets where participants keep their names off their orders, presumably to make it easier to trade with each other in larger blocks. More efficient, in theory. But the president of the keeper of dark pool statistics, Joe Gawronski of Rosenblatt Securities, declared the block dead in March. The average trade size in dark pools had dropped 48% in the last two years. The largest such pool, where firms exchanging shares stay anonymous, is Credit Suisse's Crossfinder. Its average trade size in April? 174 shares.

The spread between Liquidnet and its closest competitor is significant. Number two amongst dark pools in average trade size is the POSIT Alert block trading pool with an average size of 32,000 shares, according to Investment Technology Group, its operator. According to Rosenblatt, the average trade size in Investment Technology Group's POSIT system, overall, was 3,500 shares in April

Pipeline Trading, which was neck and neck with Liquidnet, shut down this year, after the Securities and Exchange Commission found the great majority of orders in its dark pool at times were filled at various times by a trading operation affiliated with the firm. At the end of 2010, the average trade size in the Pipeline dark pool was 46,350, according to Rosenblatt.


At the time, Liquidnet's average trade size was 47,118. But, even then, Liquidnet's average daily volume was 21.1 million shares, to Pipeline's 7.2 million.

What's Liquidnet's secret? After all, technologically speaking, it's not that hard to set a floor on the trade size in an exchange or trading system. Let each firm simply mandate what size trade it'll participate in. That was Nasdaq PSX's theory.

What appears to set Liquidnet apart instead is not technology so much as who it allows to place buy and sell orders into its pool of 'liquidity,' in the term of art for capital markets.

The only organizations who can participate are mutual funds, pension funds and other large financial institutions who have natural interest in moving large blocks. Not high-frequency traders, statistical arbitrageurs or, for that matter, the "sell side.'' The brokers and dealers whose jobs are to create more trading and more trades.

"Our core business proposition is to match orders between like-minded long-term investors,'' said Lugene Forte, Liquidnet's Head of U.S. Equities.

On any given day, the asset managers Liquidnet serves put in buy and sell orders involving about 1.8 billion shares a day in the U.S. and 10 billion worldwide. Its ratio of buy orders to sell orders runs about 50- 50, which makes it easier to move large blocks. And, in a seeming throwback to the days of 'open outcry' markets, mutual funds and other institutions can negotiate the final terms of a transaction, if they stay ''in the dark.''

But they don't have to. Liquidnet supplies "Stealth," "Fair Market Value" and six other trading algorithms that allow its institutional customers to execute large block trades with "safe" liquidity from brokers and outside venues while waiting for "natural liquidity" to arrive at Liquidnet, from other institutions. Traders decide how aggressively they want to trade and what external venues they will or won't trade in. The algos also are designed to protect their identities, as much as possible, wherever they are working on institutions' behalf.

To help make sure their customers don't get 'gamed' or identified by potentially predatory trading firms, the company polices all order flow that goes outside its own bounds. A model for the 'fair value' of securities underlies all portions of trades that end up in other venues. Antigaming logic is written into every algo. The company keeps a five-member Algorithmic Services Group on alert throughout the trading day to watch over the execution of its algos and spot any red flags.