Baikal, the non-displayed liquidity pool the London Stock Exchange (LSE) is developing in conjunction with investment bank Lehman Brothers, could help avoid excessive liquidity fragmentation in Europe, according to David Shrimpton, the LSE’s head of equity market development. The pool, which will be registered as a multilateral trading facility (MTF), is scheduled for launch in Q1 next year.
One of Bailkal’s main functions will be to aggregate liquidity from a variety of sources, including brokers’ internal pools, buy-side traders and other liquidity venues.
“If, in Europe, we can learn some lessons from the US and introduce an aggregation model early into the development cycle for dark liquidity, we will reduce the chance of having 50 venues and improve efficiency,” says Shrimpton. “We will draw in new business from those brokers and buy-side houses that feel our aggregated model gives them a chance to show their hand in a more controlled way by posting to a venue that is neutral, exchange led, well-regulated, and where there is no proprietary interest in the trading flow.”
In its bid to aggregate liquidity, Baikal will offer direct access to both the buy- and sell-side. The decision to grant the buy-side access has prompted some to question whether, with Baikal, the London Stock Exchange is pitting itself against its members, the brokers. But Shrimpton asserts that Baikal will not compete with brokers for the management of buy-side orders.
“What we are saying is that the buy-side, though gradually, increasingly wants to manage certain types of business directly,” he says. “Buy-side firms won’t want to do it with the whole of their portfolio and we expect they are going to use the very full range of the brokers’ service suite.” He adds, “We are not expecting to get large numbers of buy-side firms hooked in directly, but we don’t want to exclude them.”
Connections between brokers’ dark pools in Europe may be minimal to date, but Shrimpton believes Baikal will help the buy-side navigate the sell-side’s internal liquidity offerings. “We are hearing from buy-side firms that because there are so many broker offerings on a bilateral basis, it would be good, whether now or in the future, to be able to come into a central hub and know that their brokers could perform the same execution services for them, but within a central utility.”
Those buy-side traders that choose to connect directly can expect a number of benefits, Shrimpton believes. The MTF will trade on a pan-European basis, so traders will not need to go to different markets. Through its smart order routing facility, it will offer access to dark and lit venues, and so traders will not need to change their trading strategy if their orders are not filled immediately. And it will offer a pan-European clearing and settlement solution that will offer post trade services and trade reporting not only for the transactions executed in Baikal, but also the ones it routes to other venues. “With post-trade printing and clearing and settlement tidied up, the path is smoothed to take direct control of whatever proportion of their order flow they want,” says Shrimpton.
Although LSE has partnered with Lehman Brothers to develop Baikal, and the bank’s algorithms will be available on the platform, LSE is seeking investment from both buy- and sell-side firms, and is offering other brokers the opportunity to host their algorithms within Baikal.
“We are only three weeks post announcement but we are in very detailed discussions with both sell-side and buy-side institutions as strategic partners in a variety of models for participation,” says Shrimpton.