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Jos Schmidt
Traders Magazine Online News

Reducing the Regulatory Burden on Public Companies, Yes Please But...

In this commentary, NEO's Jos Schmidt discusses regulatory requirements and needs in the Canadian equity markets.

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January 2, 2007

The Evolving Block Trade

Industry Pros Analyze the Future of Block Trading at Traders Magazine's Conference

By Michael Scotti

Editor's Note: Where is block trading headed? That was the driving question behind our inaugural conference, "Traders Live: Block Trading in an Electronic Era." The idea was to stick to a topic for a full day, drilling down into the nuances of block trading. Below are some of the highlights from the September 27th conference. But first, some background to put the conference into context:

Block trading has taken a powder in recent years. The average trade size on the New York Stock Exchange has plummeted to just over 300 shares, roughly one-fifth the average

trade size five years ago, when decimalization began. When the minimum trading increment went to a penny, traders began hiding their orders to protect themselves from predatory traders. They displayed less liquidity, first by using floor brokers for listed stocks, and later with technology, using algorithms that chop large orders into hundreds or thousands of smaller ones. This cut the amount of block trades-individual trades of 10,000 shares or more at the NYSE-nearly in half. Consequently, the role of the sales trader and position trader changed as fewer orders went through upstairs trading desks.

Crossing networks or dark pools-undisplayed markets-are now busy trying to automate as much of the upstairs block trading business as they can. This has changed equity trading and the way traders transact. As more of these pools were launched, fragmentation became a problem. These technological advances occurred at the same time the economics of equity trading changed: Lower commissions have put additional financial pressure on Wall Street brokers and money management firms. Buyside shops responded by cutting their brokerage lists. This allowed them to better leverage their commissions to pay for services.

-Michael Scotti

Crossing Nets: A Dark Playground for Algos and Blocks," may have been the most anticipated panel of the day, given the number of new crossing systems in the marketplace. Interestingly, the launch of Level ATS was announced the morning of the conference. Equities crossing systems now number 33-and the 12 percent of buyside flow executed in these systems will continue to grow, according to Rob Hegarty, who heads securities and investments at TowerGroup. As these systems have multiplied, fragmentation-the inability to access disparate dark pools of liquidity-has became a major worry.

"We are deep in the fragmentation cycle, and we'll be in consolidation mode in the next couple of years," Hegarty said. Brokerage firms' investment in crossing systems looks like a replay of their investment strategy with electronic communication systems in the late 1990s, which resulted in the roughly one dozen ECNs merging or being acquired. Hegarty expects that crossing networks will go down a similar consolidation path.

Liquidity will be the "defining factor" that determines whether a crossing network can survive, Hegarty said. For the ECNs, it was different. Technology made them successful, as well as access and speed.

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