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January 31, 2008

AQUA Opts for Maker/Taker Pricing

By Nina Mehta

AQUA Equities, a new alternative trading system for block trades that launched in December, is zeroing in on exchanges and ECNs. Rather than compete head-to-head with other dark pools, the eSpeed spin-off, owned by eSpeed and Cantor Fitzgerald, seeks to grab flow from the displayed markets by mimicking their pricing strategies.

Through maker/taker pricing, whereby it pays liquidity providers and charges takers, AQUA aims to convince brokers to provide liquidity on the AQUA platform rather than sending that liquidity to public markets in the pursuit of rebates.

"We think a lot of the block liquidity that has been lost has disappeared into rebate-seeking algos that sit in ECNs," said Kevin Foley, president of AQUA. "That's our sleight of hand. We're competing with the venues attracting large orders that have been chopped up into little pieces."

AQUA charges buyside firms that take liquidity 2 cents per executed share. Brokers receive 25 mils, or $0.0025 per share, for providing liquidity to the system. AQUA is targeting mid-tier regional brokers that are trying to reach large buyside institutions. "That's new block liquidity we're offering the buyside, not what others are offering," Foley said.

"What AQUA is doing is particularly interesting in mid-caps and smaller, where specialized brokers may have that liquidity," said Brad Bailey, senior analyst at Boston-based research firm Aite Group. "It could be very appealing to institutions."

AQUA's pricing represents a departure for dark pools. The biggest block parties, such as Liquidnet and Pipeline, charge all customers--whether they're takers or providers of liquidity--2 cents per share. Other dark pools charge liquidity providers and takers different amounts, with the former sometimes trading for a negligible fee or for free, but no dark pools appear to pay brokers to use them.

AQUA's system is also different from most crossing platforms. Like Liquidnet and others, the system scrapes buyside blotters for natural liquidity, guaranteeing institutions anonymity. But it also gives brokers financial incentives to funnel large-size liquidity onto its platform by showing that interest only to naturals with the contra side in their blotter. In a nod to sellside interest, the system also lets participants execute block orders at the volume-weighted-average price from the point of execution until the end of the trading day.

Foley predicted that brokers using AQUA are likely to be aggressive on price "because messages are narrow-cast only to naturals." He added: "It's like the head trader picking up the hoot and holler and telling his sales traders, We're a buyer of XYZ. Call all your accounts, but only the ones with a contra order in their OMS.'"

According to Foley, AQUA currently has about a dozen participants and has executed trades, although AQUA doesn't plan to ask participants to use the system "in earnest" until it has around 50 users. He said 230 firms have agreed to participate on the platform, including 110 brokers and 120 buyside firms. AQUA also has agreements to work with all major buyside OMSs. "People have their own tech priorities," Foley said. "It's like getting horses into the gate at the start of the Kentucky Derby."

ESpeed, a publicly traded subsidiary of Cantor, contributed more than $1.1 million in cash and technology to AQUA in the first nine months of this year, and recorded a net loss of $496,000 associated with its AQUA investment over the same period. ESpeed's financial reports represent only part of the cost of building the AQUA business. "It costs money to build a good system," Foley said. Cantor owns 51 percent of AQUA, while eSpeed owns 49 percent. Foley said AQUA would consider selling an equity stake in the platform to a consortium of regional brokers later this year.

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