Wedbush Securities, a pioneer in giving high-frequency traders access to equity execution markets, recently launched a platform providing traditional institutional investors with the same high-speed access to market centers and control over their executions.
Called Colocution, Wedbush developed the platform in-house. It can be accessed over Bloomberg Sell Side Execution & Order Management system terminals. It provides direct access to Wedbush servers co-located near the Nasdaq Stock Market's exchange servers operating in Carteret, N.J.
This means mutual funds, registered investment advisors and other institutional investors can bypass the dark pools and crossing networks that most algorithms today send orders through in search of executions, before going to exchanges.
Kevin Beadles, director of electronic trading at Wedbush, said many of the firm's 500 institutional customers-a mix of traditional pension and mutual funds, registered investment advisors and hedge funds-have noted the lack of transparency in dark pools and other such venues as a major concern. The proliferation of algorithms, dark pools and crossing networks has resulted in a market where institutions' orders may be executed in any of more than 40 execution venues.
"There's minimal transparency, and investors don't know what their algorithms are doing, or whether they're achieving best execution," Beadles said.
Colocution, instead, bypasses alternative trading venues and gives customers direct access to Nasdaq, where Wedbush has been the top liquidity provider for several years. From there, Colocution customers can take advantage of Nasdaq's routing system to access other exchanges in the U.S. and around the world.
The Los Angeles-based broker-dealer built its own data ticker plant and order book to display best pricing from exchanges and other networks, capture it in real-time, and compile a "supersized" order book-enabling orders to be executed in less than a millisecond, Wedbush said.
In addition to giving users nearly real-time information about where liquidity resides, the platform allows funds to see precisely where their trades are executed.
Perhaps the biggest challenge faced by traditional institutional investors today is moving their block orders as anonymously as possible through a market teeming with high-frequency traders. These traders use sophisticated technology looking for patterns in market activity, to jump ahead of big orders. This increases trading costs for investors. Typical buy-side strategies to maintain anonymity have included breaking up larger orders into tiny pieces and execute them across the market, and finding liquidity in dark pools that don't display quotes.
Colocution may be another tool.
Phil Krauss, director of trading at Harris Investment Management, said speed in execution is becoming ever more essential, for large investors. "We want to be on the same playing field as far as speed. If you see 5,000 shares at a venue, everyone wants to be able to beat others to the punch," he said.
Wedbush is a top liquidity provider to Nasdaq because it clears for broker-dealers catering to HFTs and aggregates their trades under its own market participant ID (MPID). This gives them access to the exchanges' lowest fees for taking liquidity and highest rebates for providing it. In another potential benefit, Colocution customers share the same exchange pricing benefits.
Brokerage competitors have taken different approaches to providing institutional customers with transparency and optimal pricing.
"We've built a business around real-time trade reporting and transparency, and trade evaluation," said Chris Heckman, managing director responsible for U.S. sales at Investment Technology Group.
While ITG gives clients the ability "to turn the dials and set parameters themselves," Heckman notes, most rely on ITG's expertise and ability to monitor the market continuously to improve trade performance. "We're offering a complete suite of tools to clients, and clients pay us for that."
Wedbush, which launched Colocution in mid-December, is instead handing the reins to institutional clients' traders, or their algorithms, which Wedbush can develop for them. "We're capturing in real-time where their executions are being done. So if they're trading in a certain name and see a lot of it being done on NYSE Arca, they can choose to route more of the order there," Beadles said. "It puts more control in institutions' hands."
Plus, Beadles added, Wedbush passes on exchange rebates to Colocution users, potentially lowering their executions costs.
Colocution's benefits, however, may be more appropriate for some buy-side investors over others. Krauss says "plain vanilla" institutions such as Harris Investments typically have a set number of orders given to their traders, and so his firm is usually a liquidity taker and thus less able to benefit from the exchange rebates.
"Traditionally, institutions have been liquidity takers, and for a reason: the anonymity," said Sang Lee, co-founder and managing partner of Boston-based research firm Aite Group.
Krauss says Colocution may be most appropriate for nimbler institutions, such as hedge funds. They could enter the market as a liquidity provider, capture the rebate, and then jump to the other side of the trade to follow the price momentum.
Nonetheless, adopting HFT strategies and tools could play a useful role in enabling traditional investors to execute their larger orders, Beadles said. An investor trading a basket of stocks, for example, could peg orders to the best bid or offer and receive fills-and rebates. If trading individual stocks, a buy-side trader could quickly access the market to capture liquidity by using immediate or cancel (IOC) orders, in which a portion of an order not immediately filled is canceled.
Capturing market center rebates could present another obstacle for traditional institutions, since they must allocate trades to multiple accounts. But, Beadles said, rebates can be handled in a few ways. Wedbush's effective commission rate could be lowered daily at the point of processing, so if the base rate is a penny per share and the institution's trades generate $0.002 per share, the brokerage would charge $0.008 per share. Or if an institution averages $0.002 per share in rebates per month, the penny commission could be lowered to $0.008 the next month.
Krauss says changing commission rates daily on a trade-by-trade basis is too complicated, but reducing the commission rate based on the previous month's rebates could work. He notes that currently he does not trade domestic equities over his Bloomberg terminal. "But I will be shortly, and I'll probably give [Colocution] a try once I'm up and running."
