Pipeline Trading is introducing a new service for its buyside customers that is inspired in part by the Liquidnet methodology. The dark pool operator says it took only what it considers Liquidnet’s best features.
The new functionality allows Pipeline’s buyside customers to narrow the field of potential counterparties. This should, Pipeline believes, increase their chances of finding the other sides of their trades.
“We are transferring power to the trader and away from the system,” says Fred Federspiel, Pipeline’ chief executive. “Our customers have asked for more direct trading opportunities, more buyside targeted trading opportunities.”
Now, when a customer with a large block to trade seeks a match in Pipeline, he drops a firm order into the dark pool and waits for a response from another Pipeline member. The system broadcasts a message to every Pipeline user, informing them of the presence of the order. It gives them the name of the security, but nothing else.
The limited amount of information and the fact that the notice is often not sent out immediately can combine to cause time delays that frustrate traders and thwart transactions.
So to increase the odds the customer will find the other side of his trade, Pipeline is making a big change. It will continue to send a message to all users, but the message will be encrypted and only readable by a qualified group of buyside members. The recipients must have either traded the stock earlier in the day or hold a contra-sided order.
This “narrowcasting” is meant to eliminate the time delays inherent in Pipeline’s original model and the frequency of mismatches.
Under the current system, trades may not occur because recipients are on the same side of the market or the message arrived too late. Pipeline purposely sends out messages late sometimes to reduce the pricing information the recipient is able to glean.
To make the new model, dubbed “Pipeline Powerplay,” work, the dark pool operator will use a technique made popular by Liquidnet: It will “scrape” its members’ blotters, or order management systems, for information. Unlike the Liquidnet process, however, the information will remain on Pipeline software on the trader’s computer.
Liquidnet captures the information on its members’ blotters and holds it in a central repository. Those members holding buy and sell orders in the same stock are then notified of the positions of the others in hopes of coaxing them to negotiate a trade.
Pipeline maintains Liquidnet’s methodology is flawed because it makes it possible for members to sniff out the interest in a given stock without any requirement to trade. All a trader has to do is to drop an order on his blotter and he will be alerted as to the available contra-sided interest.
By contrast, Pipeline does not draw the blotter data into a central system and make it universally accessible. The information remains in Pipeline’s software inside the trader’s system. The trader who drops a firm order into Pipeline’s system is not made aware of the contra-party unless a trade takes place.
Executives at Liquidnet do not dispute the fact that traders using their system gain information without an obligation to trade. They point out however they “rigorously survey and monitor behavior” on the system.
“We continue to safeguard our pool better than anybody,” Alfred Eskandar, Liquidnet’s global head of corporate strategy, said. “We have strict membership requirements.”
Eskandar also pointed out Pipeline’s new service does not eliminate information leakage. A message sent to a trader who has traded the security but does not have a contra-sided order on his blotter amounts to sharing information with someone who may not be interested in trading again.
“That is not accurate enough,” Eskandar said. “That’s past tense. The train has already left the station.”
Liquidnet is nearly three times the size of Pipeline. In 2008, it traded, on average, 38.6 million shares per day, single-counted, according to research done by Rosenblatt Securities, Inc. Pipeline processed 13.9 million.
Pipeline is not the first broker to incorporate blotter-scraping technology into its dark pool offering. Investment Technology Group, Pulse Trading and Aqua Equities have are also using the technique. Liquidnet, which holds a patent on the technology, is suing ITG and Pulse for patent infringement.
Pipeline spent two years developing its new service, mainly to get the encryption right. It has received support by some very large institutions, according to Federspiel, who do not use Liquidnet. “This will get used heavily,” Federspiel said.
