The year just passed witnessed the transformation of the indication of interest.
Long a plain vanilla communication tool between the sellside and the buyside, the IOI is being reinvented to meet the requirements of a new era of trading: Buyside to buyside communication, dark pool to sellside communication, exchange to dark pool communication, trading engine to trading engine communication. The uses being found for the IOI are increasingly varied.
Some are raising eyebrows. Control over IOIs is still largely in the hands of the big brokers, but that era may be coming to an end. This spring, BlockCross ATS, developed by Pulse Trading, signed an agreement with Bloomberg Tradebook to broadcast the trading interests of BlockCross’s buyside customers out over Bloomberg’s IOI network. The IOIs would originate from orders sitting in the BlockCross dark pool and go out over Bloomberg’s network under the BLKX name. The set-up puts members of the buyside in direct communication with each other as all buyside traders would understand that a BLKX IOI was generated by another buyside trader.
This did not sit well with many large firms on the sellside, who saw the deal as another attempt to disintermediate them.
NYFIX has a similar move in the works, but on a small scale. Earlier this year, it bought the operator of a small British IOI network called Fixcity. NYFIX has many plans for this acquisition. One is to run IOIs out to the buyside generated from orders resident in its Millennium dark pool. AQUA Equities is another pool that is “narrow-casting” indications for bocks to buysiders with contra-side interest.
The practice of dark pools broadcasting indications is generating controversy of its own. Some pools create IOIs based on orders they hold, and transmit them to brokers’ algorithmic trading engines. The buyside trader who owns the order may or may not be aware of the practice. A Traders Magazine survey several months ago showed that many weren’t.
One concern for buysiders is information leakage. The conception most traders have of dark pools is that their resident orders are passive and hidden from view. That encourages traders to post large orders in pools.
Given the new trend, dark pools may not be as opaque as they seem. Some are being called gray pools to reflect this liquidity-seeking activity. JPMorgan launched a gray pool earlier this year called Lighthouse. Most brokers who operate gray pools, including JPMorgan, say they will not transmit IOIs based on client orders without their okay.
The leakage issue notwithstanding, machine-to-machine communication is becoming a bigger part of IOI usage. Under the gray pool scenario, IOIs are sent from the pool to trading engines, with no humans ever seeing the message. The recipient machine often must respond with an immediate-or-cancel order if it has the contra side.
Dark pools aren’t restricting their IOI-sending to broker-dealers and money managers. They have also entered into arrangements with market centers, including two of the largest exchanges. NYSE Arca, for example, will pass an outbound routed order through a “cloud” of electronic indications from as many as 29 dark pools. The order executes against indications pooled in the cloud before being routed to protected quotes on other markets. Customers that execute against the cloud are guaranteed NBBO-or-better executions.
Also in the machine-machine category, Knight Link, an IOI-like product from Knight Equity Markets, has been sending out indications it chooses to refer to simply as “available liquidity” to broker-dealers since early 2007. However, unlike dark pools, these indications are based on Knight’s own flow, not customer orders.
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