It's one of the old est alternative trading systems, but also one of the smallest. Not satisfied with its size, the electronic crossing network Lattice has launched an aggressive campaign to boost its volume.
State Street Brokerage, a unit of State Street Global Management, itself a unit of Boston buy-side giant State Street Global Advisors, hopes to attract more institutional traders to its ten year-old system with a big marketing push and improvements to Lattice's functionality. The move is part of a broader effort by State Street Global Management to promote its GlobalLink platform. That technology supports Lattice as well as trading systems for foreign exchange and bonds.
"We are spending a significant amount of money," said Stephen Schoenfeld, senior vice president in charge of marketing at Lattice. "Especially now that Lattice is part of GlobalLink."
Schoenfeld was recently hired from the now-defunct ATS OptiMark. He spent several years as a manager of Lehman Brothers' New York Stock Exchange operations as well as running his own discount brokerage and a regional specialist firm.
Schoenfeld's hire comes as State Street goes through a major reorganization that left State Street Brokerage president Nicholas Bonn reporting to State Street Global Management executive vice president Stan Shelton.
The agency brokerage is "spending millions," according to Schoenfeld, to hire salespeople and wire Lattice to order management systems, electronic communication networks and Nasdaq market makers.
Observers say the company's move is long overdue, but it still faces trader resistance and a host of new competitors.
In addition to its three main rivals – POSIT, Instinet, and the New York Stock Exchange – Lattice faces increased competition from newcomers. A resuscitated Arizona Stock Exchange, NYFIX Millennium, Liquidnet and WOFEX are all vying for the same institutional block and basket trades.
"My job is to build an eco-system," Schoenfeld said. "That means bringing together a multitude of different types of clients. That will increase the chances of any one user finding a match."
Schoenfeld's problem is like that of the chicken and the egg. Traders won't use Lattice unless traders use Lattice. Liquidity begets liquidity.
Right now Lattice processes just 12 million to 15 million shares per day on average for about 100 buy-side customers. That's half the tally chalked up daily by rival POSIT and considerably less than that of the principal ECNs.
A Lattice sales team of five just a few months ago will climb to nine before the end of the year. Four sales traders will become six. "There are a lot of new faces here," Schoenfeld said. "We're hiring so many because we want to see volume increase. We've attracted people from ITG, BNY ESI and other competitors."
Lattice the system is being augmented as well. Schoenfeld intends to integrate it with all of the OMSs – about ten – used by the buyside. The buyside is now compatible with just a few. An agreement with Boston's Eze Castle will make the OMS vendor's TradersConsole product the default OMS for traders who don't have OMSs.
Schoenfeld is also taking steps to increase the number of Nasdaq destinations to which Lattice routes unmatched orders. Predominantly used for listed shares, Lattice now transmits to the New York, American and Boston stock exchanges as well as to an undisclosed Nasdaq market maker.
Schoenfeld is talking with ECNs and other Nasdaq dealers. He is not talking with other regional exchanges.
An agreement with the popular financial extranet IXnet will make Lattice accessible by some 500 financial institutions. Traders previously accessed Lattice over Bridge's network; most have been converted to IXnet.
In addition, State Street is developing a transaction cost analysis product to help buy-side traders measure market impact costs. Here the broker will play catch up to such agency broker competitors as Instinet, ITG and Abel-Noser, and consultant Plexus Group.
Win Back Blocks
A key goal of Schoenfeld is to win more block trades. He claims a continuous matching engine like Lattice is superior to a periodic call auction. "The odds of one institution meeting just one other institution on a single day at a single time at a single price are low," he said. "Customers have a much greater chance of meeting with a continuous match."
The periodic call auction is the modus operandi of POSIT which crosses large blocks of single stocks. Lattice is best known for its continuous executions of multiple-security baskets containing smaller numbers of shares. The average execution in Lattice is 800 shares. In POSIT, it's 5,200 shares, according to POSIT marketing executive Mike Neumark.
Rob Hegarty, an analyst at TowerGroup, a securities industry research firm in Needham, Mass., rejects Schoenfeld's assessment and defends the call auction.
"You bring more people to the party when you send out invitations," he said. "When you run an open house, people say Maybe I'll drop by. Maybe I won't.' POSIT concentrates liquidity. If everybody meets at 10:30 on POSIT you have a better chance to get a trade done."
The proof, so far, is in the pudding. Lattice's volume is half of POSIT's. And with a 10 percent to 20 percent fill rate it leaves at least 80 million shares on the table every day.
"The block business is something that must be built over time," Hegarty said. The former trading technologist with Fidelity and Putnam attributes the weak volume on Lattice to inadequate marketing and trader apathy.
"It takes a lot of work to deal with these systems," he said. "You need a good likelihood that your order will get filled."
Buy-side traders say there is a place for Lattice in their work flow, but point out the risks of letting a block order "float" there. They fear they could miss or be wounded by the market if they let it float too long.
Schoenfeld acknowledges Lattice is "not designed for immediacy," but says an order doesn't have to float at all. It can be automatically routed to an alternate execution point. That's a key difference between Lattice and POSIT and something Schoenfeld feels is not appreciated by many on the buyside.
If a trader's order goes unexecuted in POSIT it is cancelled. It can then be worked by a sales trader at ITG or elsewhere. If a trader's order goes unmatched in Lattice, however, it can be automatically routed to the NYSE, the AMEX, the Boston Stock Exchange or Nasdaq. It can also be cancelled and worked by a broker.
"You can slice your order and send pieces down to the floor if you don't find liquidity," Schoenfeld explained. "That is a powerful story that hasn't been told to the institutional community."
Market Impact
According to Hegarty most block traders that don't get a match in Lattice are unlikely to ship their order directly to the specialist via DOT. They fear market impact. They usually cancel the order and then have it worked by their sales traders.
If that's true then the new NYFIX Millennium crossing mechanism could be one step ahead of Lattice. If an order goes unmatched in that system it can be routed to a floor broker. The buy-side trader gets a shot at a match and receives broker protection as well. Millennium is sponsored by some of the largest full service brokers on the Street. They reportedly send 200 million shares a day through the pipes of the ATS's parent NYFIX to the NYSE floor.
Lattice has stared down the competition before, however. At about the same time industry legend Evan Schulman introduced Lattice buy-side giant Fidelity brought out a crossing mechanism of its own. Called Investors Liquidity Network it died after three or four years.
Schoenfeld knows he has a fight on his hands. "There's no perfect system," he said. "But I think Lattice gives traders the best of both worlds. They can be out there anonymously and still access the market. We have critical mass and are building more."
Lattice at Work
Lattice specializes in baskets and smaller orders. Since they are destined for DOT anyway, it makes sense to first send them through a crossing mechanism where they might find price improvement.
"You're crazy if you use a straight DOT machine," noted Lattice sales trader Adrian Lorimer. ("DOT-boxes" are standard-issue equipment supplied by brokers that allow buy-side traders to send their small orders to an exchange floor without involving their sales traders.)
Much of Lattice's success with baskets must be credited to State Street Brokerage's transition management business. That group helps plan sponsors "transition" their portfolios from one money manager to another. Those portfolios first trade internally against the orders of State Street Global Advisors, State Street Global Market's parent, and the third largest money manager in the world with some $600 billion in assets under management. After that they are funneled into Lattice. There they have a greater percentage of matches than the average Lattice order because they use indications of interest to attract counterparties, according to Stephen Schoenfeld of Lattice.
Those transition management orders are a big draw for baskets traders.
"Don't discount those transition management orders," Schoenfeld said. "They're not out there in the marketplace."
Crossing Networks
Crossing networks offer lower trading costs. Traders save money through cheaper access fees, reduced market impact costs or both. They suffer the latter when word of their large trades leaks out and prices move against them.
Most crossing networks are closed books. No one knows what orders they contain. In that way, they differ from ECNs whose bids and offers are open to public scrutiny. In addition, ECN order flow is predominantly small and in Nasdaq issues. Crossing systems process blocks or baskets, chiefly of listed names.
