Innovating in the dark

The buy-side’s need for blocks and the incoming caps on dark trading are driving brokers to seek out new solutions.

The buy-side’s need for blocks and the incoming caps on dark trading are driving brokers to seek out new solutions.

Brokers say they are responding to client demand with new block trading offerings. Why has demand shifted in favour of blocks?

While some would argue that long-term investors have always been interested in block trading, brokers say market conditions today are leading to an increased desire to trade in large blocks. The key change is in the macro-economic environment, which has improved markedly over the past one to two years. While late 2012 and early 2013 saw continued concern about the long-term future of the euro-zone, today those fears have largely vanished. Some European countries, particularly those badly hit in the crisis, have begun to turn around and others such as the UK are also seeing strong GDP growth.

It has often been remarked that, since the financial crisis, investors have rejected stock picking in favour of investing in indices as stocks have been highly correlated. As the economic situation has improved, investors are making a return to stock picking and taking larger positions in individual names, requiring them to trade blocks of shares.

Of course, the regulatory environment cannot be ignored and dark pool caps in MiFID II are expected to push more firms to seek block trades in order to continue trading in the dark, as dark pools that operate the large-in-scale waiver will be unaffected by the new rules.

How is the sell-side innovating to help meet this demand?

Many brokers are now looking at new ways to improve the number blocks they are able to trade for clients, but approaches have varied. Some have sought to improve the amount of control the buy-side has over how their orders are executed. The thinking goes that, if the process is more transparent and institutional investors have protection from potential predatory flow, then they will be more willing to place and rest large orders. This in turn increases the chances of a suitable match being found.

Trading venues are also getting in on the game. London Stock Exchange Group (LSEG) has bee particularly active in this area. It’s main London market is currently consulting on introducing an intra-day auction. Auctions can be helpful in securing block trades, but at present only happen on market open or close, meaning they are often used to clear up outstanding parts of an order as the day ends. The intra-day auction would offer the chance to work an order in the morning before securing a block trade at auction and working any remaining shares later in the day.

LSEG’s Turquoise multilateral trading facility is also pushing its Uncross service, which provides randomised matching of orders to eliminate latency arbitrage strategies and augmenting it with new block trading functionality. 

What about the role of sales traders?

Sales traders have become a core part of the sell-side’s arsenal in enabling clients to trade blocks. Algorithmic trading has been around so long that many buy-siders feel other market participants are more able to game it, resulting in it being less anonymous than it once was and more prone to market impact. There have also been concerns that the separation of sales and electronic trading has broken down at some brokers, leading to additional information leakage

For many banks, finding ways to integrate their electronic trading and sales traders, while also preserving anonymity, is core to improving block crossing. Goldman Sachs’ Contingent Crossing services aims to provide sales traders with limited information on electronic order flow, maintaining some anonymity but also enabling the high-touch desk to step in when a potential match is found to facilitate a negotiated trade.