If the term dark pools did not sound ominous enough, when it first came to light that a consortium of the industry's biggest asset managers quietly had come together to start their own dark pool earlier this year, the effort had a faint ring of corporate intrigue.
The automatic trading system called Luminex and led by Fidelity includes Bank of New York Mellon, BlackRock, Capital Group, Invesco, J.P. Morgan Asset Management, MFS Investment Management, State Street Global Advisors and T. Rowe Price. Together they manage over $8 trillion - roughly 40% of U.S. assets.
The firms have said the reason for creating Luminex, despite the presence of 15 American securities exchanges registered with the SEC and more than 50 dark pools currently operating, was because of the challenges in trading large blocks in those existing stock markets. According to a study by the SEC, the average size of a trade is 200 shares.
The ATS is planned to begin operating by the end of next month. Just don't call it a dark pool.
"Luminex is a dark pool with the lights on," said a consultant working with the new trading venue. The founders' intention is transparency: a confidential, cost-effective venue for large block trades. Also, it won't be operating for profit. "Luminex will fix what is broken in this sliver of the market and benefit the end fund-owner" by passing along the lower cost of its trades, said the consultant.
Post-Regulation National Market System, the number of trading venues has exploded, electronic trading has dramatically increased speed, and market-makers have embraced high-frequency trading.
The process of trading has frequently become a multi-step process where one transaction will be preceded by 10 trading gestures to gauge the market, with information leaking along the way. One often-noted trend has been the decrease in the size of trades in dark pools. Block trades typically get shredded into an average size of 187 shares. This is actually smaller than the 200-share average size of a trade on the exchanges.
FRUSTRATIONS INHERENT
SEC Commissioner Mary Jo White listed market structure as a primary issue for 2015, including the lack of transparency in dark pools, and has a preference for market-driven solutions. To that end, Luminex will have transparent trading protocols and rules; members will be treated equally, and must agree to have their participation in the venue publicly disclosed.
Trades will have a minimum of 5,000 shares or $100,000. There will be no shredding of orders. When a match is found, execution is guaranteed. There's no falling down on trades, so testing the market will be eliminated. Once there is a match, traders can size up. The structure intentionally returns to a more straightforward trading process that was fragmented by Reg NMS.
One source described the frustrations inherent in the way the present system functions. "If you are a large asset manager and you have a large block of shares, and you bring it to a dark pool and it gets immediately shredded up, into thousands of high-frequency trades that fall down and expose your interest, that is a real problem. If you take your 5,000-block share to Luminex, nobody can take a peek at your interest, go somewhere else and move against it, or send in hundreds of orders at various prices."
CRITICAL MASS
Luminex will allow only long-oriented firms to trade - hedge funds will be welcome but not HFTs. Decisions on what constitutes an acceptably long-oriented firm will be made on a case-by-case basis. One observer commented that Capital, a consortium member, certainly places plenty of short trades.
A representative from The Capital Group said it does not have any funds or clients that currently engage in short selling.
Luminex does not see itself as a competitor to IEX, the buyside pool that hopes to become a buyside exchange. "IEX has its own business model, and this isn't about competing against any particular pool," said Stephen Austin from Fidelity. Luminex sees itself as a utility. "The goal is to generate enough business to operate at cost. They will retain no profit at the equity-owner level."
Interim CEO Michael Cashel noted that Luminex seeks to pinpoint what is not working and correct it. "We did a lot of research with the asset management community," he said.
"One of the specific pain points mentioned was the frustration traders have when trades fall down. Within Luminex, when you place an order, you are committing to making a trade if there is a counterparty and both of your orders are marketable."
Cashel is aware there may be bumps in the road: "We've now spoken to more than 175 market participants, most of whom who have expressed interest in trading on the platform. We recognize the challenge of having a critical mass of liquidity, and it is one of the biggest challenges that we face, but we're optimistic."
EXECUTIVE HIRE
In June, Luminex selected its first permanent CEO, Johnathan Clark, who is currently co-head of equities trading for the Americas at BlackRock. He had been a vice president at Merrill Lynch Investment Management, joining BlackRock when it acquired the unit in 2006.
Clark is set to join the Boston-based company Aug. 1, and the selection is pending regulator approval. Analysts see his hire as a bridge to the industry.
"Jon's unique insights, proven track record in building efficient trading operations and perspective on the challenges facing participants in today's markets are a perfect fit for Luminex," Michael Cashel, the interim CEO, said in a statement.
"We are confident under his leadership, Luminex will become an attractive option for investment managers." - With reporting from Bloomberg News.
