15 Variations of Dark Books and their Algorithmic Aggregators
NEW YORK, NY, April 3, 2006 â The search for liquidity in todayâs financial markets has given rise to an increasing number of traders who are turning to brokers and alternative systems offering new crossing networks and related non-quoted pools of liquidity that tap hidden liquidity to locate crossing opportunities. As Jeromee Johnson, TABB Group senior analyst and author of the report issued today, âLocating the Invisible: Aggregating Dark Book Liquidityâ, explains, âThese new dark books are vying for market and mind share at the same time the existing popular networks continue to experience record volumes.â
According to TABB Group, the combined crossing network volume in the marketplace has grown to 9% of total equity trading volume, projected to increase by 3% a year for the next several years. âThe firms that can appropriately incorporate these dark books in their algorithm and trading strategies will not only gain a performance edge but a tool that will vastly simplify the process of making the most difficult trades,â writes Johnson.
Dark books are limit order books or trading networks that do not publish a quote in the open market. By attempting to create a safe environment where large liquidity providers can locate large liquidity seekers without the risk of being traded ahead of, crossing networks try to minimize market impact and information liquidity and simplify the trading process. In recent months, notes Johnson, a record volume of trades have been executed using as many as 15 different variations of crossing networks, which Johnson classifies into four categories: scheduled crosses; continuous blind crosses; continuous advertised and continuous negotiated crosses; and internal crossing systems.
However, the popularity of crossing networks and dark books is further fragmenting a type of order flow that to date has been difficult to bridge. âA further fracturing and fragmentation of liquidity between not only the block trading markets but between and across all of the ATS venues is happening now,â says Johnson. âThe largest pools of block liquidity â LiquidNet, Pipeline and POSIT â will survive and grow through the market structure changes ahead.â
While TABB Group believes that the incorporation of dark books into algorithms and aggregation tools is well underway and will be the common way to access many of the block trading systems and dark pools of liquidity within the next two years, TABB Group CEO Larry Tabb adds a cautionary note. âThereâs not sufficient room in the market for the number of continuous blind crossing networks that exist today. As we saw with the closing of Harborside+, if your market structure doesnât differentiate and add value, it will be impossible to survive as a competitive venue.â
Findings from the 22-page report include:
Â· Slightly more than 60% of buy-side firms interviewed strongly believe that proprietary orders participating in an internal market should do so only in a blind black box implementation.
Â· The block trading landscape has begun to take shape around a handful of different crossing systems, including LiquidNet and Pipeline; POSIT and NASDAQ Closing Cross; and a small number of blind continuous crossing networks and internal crossing systems.
Â· Only one crossing network provider currently works with more than 10 different aggregators. However, TABB Group predicts that within the next 12 as many as three other providers will be working with four to as many as 10 external aggregators.
Â· Nearly 25% of crossing system providers credit algorithmic participation as the largest factor in recent volume increases.
Â· Credit Suisse, ITG, Piper Jaffray and Goldman Sachs have developed algorithms that target crossing networks and alternative trading systems (ATSs).