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July 15, 2007

Betting on BIDS

The Biggest Trading Houses Join Hands in a New Crossing Venture

By Peter Chapman

Twelve of the largest trading houses have banded together to launch an electronic crossing venture. Will their clout make it the dominant system on the Street?

That's the open question now that BIDS Trading has started operating. BIDS, which stands for Block Interest Discovery Service, was formed by the eleven largest investment banks (see table) and Knight Trading Group. It joins many so-called "dark pools" strewn across the trading landscape, but has the potential to become a blockbuster hit. BIDS' backers collectively control nearly three-fourths of the industry's share volume.

And after just one month of operation, BIDS' volume was averaging between 11 million and 13 million shares per day. That's put the start-up hot on the heels of the established players, which typically do between 30 and 50 million shares daily.

"Our investors want an efficient space for themselves and their clients to trade large blocks of stock," BIDS chief executive Tim Mahoney tells Traders Magazine. "We think our model-open, flexible utility-is incredibly important."

Mahoney should know. Before signing on with BIDS last September, he was head trader at Merrill Lynch Investment Management, an institutional investor with $100 billion in equities under management. There, he oversaw 14 traders and participated in the institutional traders advisory committees of both the New York Stock Exchange and Nasdaq. He developed strong relationships with the sellside, especially among the larger firms.

Block First

Tim was really one of the more thoughtful people about market structure," says Michael Bleich, a BIDS board member and Lehman Brothers executive. "He was involved in the early experiments with some of the other crossing systems. He's very knowledgeable."

Electronic crossing has gone mainstream in the past year or two, as the number of platforms has surged. There are now about two dozen in operation. Most are owned by broker-dealers, either full-service or agency. Eight of BIDS' backers operate their own systems.

The trading platforms can be broadly lumped into two categories. Half, which take a "block first" approach, are stringently optimized for trading large orders. The other half are more liberal vehicles that mix large orders with streams of small flow. The latter group includes most of the systems operated by the large full-service firms, including BIDS's backers. These "flow-based" systems focus on high-frequency, low-latency trades. Execution sizes are often small.

BIDS falls into the first category. Its mandate is to offer brokers and money managers the ability to match large buy and sell orders using filters and screens that allow them to limit their counterparties.

The block-firsters can be further broken down into two groups: those operated by agency brokers and those operated by exchanges or broker consortia. Here, BIDS falls into the second category. These industry utility types are largely untested; none are more than a year old.

TABB Group, a Boston-based research organization, groups the players into three categories as well: block crossing alternative trading systems, broker-dealer internal markets and exchange crosses. It expects overall share volume on these platforms to grow from an average 512 million shares per day this year to about 1.5 billion shares daily in 2010. That reflects a rise in market share from 9.4 percent this year to 15 percent in 2010.

The Agency Brokers

At this point, success in the electronic