In a deal announced Wednesday, Pipeline Financial Group, which operates the Pipeline equities crossing platform, gained an options crossing platform and expanded its block trading horizons by acquiring 3D Markets. 3D is a two-year-old company that created a platform to execute block trades in options with little or no market impact.
Pipeline expects the addition of 3D’s technology to broaden the company’s prospects and enable institutions to execute blocks more easily in related asset classes. “We’ll allow the two offerings to operate side by side immediately and work with customers over the next few months to figure out how to integrate them,” said Fred Federspiel, CEO of Pipeline.
Aspects of 3D’s technology could also help equities traders in other ways. “We will use this acquisition to look at different ways the options trading world can help the large block equity trader who’s looking to accumulate a significant position,” Federspiel added. He declined to elaborate on how Pipeline might do this.
For 3D, the benefits of the deal are clear: distribution and access to Pipeline’s 400-plus institutions. “3D has proven out the technology and were looking for a partner to get their technology distributed to the institutional community,” Federspiel said. “We were interested in their Archangel product.”
Archangel is 3D’s platform for two types of options trades: block trades in which institutions get blind bids from liquidity providers without giving up the name of the underlying stock, and benchmark crosses based on a proprietary GWAP benchmark. GWAP, which stands for gamma-weighted average price, is akin to an equities volume-weighted average price but is for options.
The Chicago Board Options Exchange has an agreement with 3D to offer a facility to trade GWAP benchmark trades prior to the open, subject to approval by the Securities and Exchange Commission. That deal will remain in place with Pipeline. “We will deploy the GWAP cross with the CBOE,” Federspiel said. “We hope it will be a significant product for institutions.”
“The long-term goal of the deal is to create a multi-asset block trading platform,” said Paul Zubulake, senior analyst for options and futures at research firm Aite Group. “The buyside has always favored the idea of trading large quantities of options at a single price point with anonymity,” he added, noting that a dual-asset-class platform could make that process easier.
But the attraction for Pipeline may be broader. “The deal also provides Pipeline with equity option market knowledge and an agreement with the CBOE,” Zubulake said. “The questions are, Will there be any issues with platform integration, and will the regulatory landscape change?”
Currently, all options trades must execute on exchanges to be cleared by the Options Clearing Corp. 3D sends its crosses to several exchanges for execution. It executes several blocks every week, according to David Mortimer, 3D’s chairman and CEO. On the benchmark front, the proposed Options Linkage Plan that’s waiting for SEC approval includes an exception for benchmark trades.
Jen Setzenfand, vice president and senior trader at Federated Investors, based in Pittsburgh, notes that enabling equities executions to occur in conjunction with options trades benefits institutions. “Many options trades are packaged with stock,” she said. “Moving a block of options contracts with or without stock but with no information leakage gives you an advantage in the market, even if it takes a few minutes longer. Having access to the equities market for big options trades should make that easier.” Setzenfand added that the benefit for 3D of pairing up with Pipeline “is that Pipeline is a big name and runs a system that’s already on people’s desktops.”
Mortimer notes that while his firm developed a crossing platform and auction methodology to enable executions without revealing the underlying name prior to the trade, the firm never developed a distribution system. “Currently, only a small portion of institutional customers are interested in connecting electronically to our system,” he said. 3D has about 20 institutional participants.
All but one of these institutions, which uses the web-based version of the firm’s system, seek out blocks on 3D by picking up the phone. They call someone at the 3D service desk, who enters the trade information onto the Archangel platform, which then decomposes the order into a risk profile. The 3D employee conveys the blind bids that arrive back to the customer for the negotiation process. The difficulty with providing FIX connectivity to institutions, Mortimer said, is the lack of standardized symbology in the options industry. Pipeline’s desktop access, he said, gets around that problem.
In addition to the need for distribution, 3D didn’t have enough capital to build out its market and get bigger customers. “To get approved by some clients, you must have a certain amount of capital, and Pipeline easily crosses that hurdle for those with that concern,” Mortimer said.
Pipeline did not disclose the amount it paid for 3D. As part of the deal, Pipeline’s roster of close to 100 employees gained 3D’s staff of seven, including Mortimer, IT developers, salespeople and compliance officials. Pipeline plans to retain all of them. Jeromee Johnson, 3D’s president, left 3D last month and joined BATS Exchange as vice president for market development.
While the 3D deal was being negotiated, Pipeline was also at work branching out in Europe. Pipeline’s European platform recently received authorization from the Financial Services Authority in London to operate a multilateral trading facility for non-displayed block trades in pan-European stocks. The platform is expected to launch in May, Federspiel said.
