Can Dark Pool Luminex Unlock Enough Liquidity for Block Trades?

Backed by nine of the world’s top asset managers, the new venue aims to create a safe environment for buy-side investors.

Institutional Investor

June 2015


By Robert Stowe England


Five years after the flash crash, buy-side investors aren’t sleeping any easier. The recent arrest of British trader Navinder Singh Sarao for allegedly helping trigger that event, which sent U.S. stock markets into a brief and sharp tailspin, reminded them how perilous buying and selling securities has become. Among other charges, the Commodity Futures Trading Commission has accused Sarao of repeatedly placing orders he planned to cancel, an illegal activity known as spoofing.


As they hunt for liquidity — and try to avoid showing their hand to high frequency traders and market makers — buy-side firms are all too familiar with illusory offers. Those seeking refuge in one of dozens of dark pools, private venues where parties can execute large trades before the details become public, often try to confirm an offer only to see it vanish.


“They hate the fact the other side of the trade walked away and took information from them,” says Michael Cashel, a senior vice president at Fidelity Trading Ventures, a division of Fidelity Investments, headquartered in Boston. Having learned that someone is looking to buy a big block of shares, the other party can profit from that knowledge.


In search of a safe haven, nine large asset managers led by Fidelity have joined forces to create their own dark pool, Luminex Trading & Analytics. Cashel serves as interim CEO of the Boston-based venue, which is slated to go live by the end of September.


Luminex will be open only to the buy side. Besides attracting a large and diverse group of investors, the plan is to simplify orders for institutional block trades and stop information leaks. This new player may offer protections missing from current dark pools, but can it provide enough liquidity to reach critical mass?


When it comes to liquidity, Luminex has one clear advantage: The nine co-sponsors manage about 40 percent of U.S. mutual fund and exchange-traded fund equity assets, it estimates. Besides Fidelity, they include Bank of New York Mellon Corp., BlackRock, Capital Group Cos., Invesco, J.P. Morgan Asset Management, MFS Investment Management, State Street Global Advisors and T. Rowe Price. Another 175 asset managers have signaled that they would like to sign on.


“I’m sure that this will be successful,” says Manoj Narang, founder and former CEO of Tradeworx, a high frequency trading firm based in Red Bank, New Jersey. “You’re talking about some of the largest asset managers in the world.”


Luminex won’t reinvent dark pools, which handled 16.11 percent of consolidated U.S. equity trading volume last year, according to Rosenblatt Securities, a New York–based institutional agency brokerage. That’s slightly off 2013, when volume peaked at 16.63 percent.


“They’re not trying to replace the existing market structure or take over the world,” Justin Schack, a managing director and partner at Rosenblatt, says of Luminex, which he describes as a utility-like service with a good chance of success. “They are trying to carve out a niche and provide a low-cost way for asset managers to cross blocks with one another. It’s a pretty narrow and well-defined goal.”


Unlike its competitors, Luminex is owned and run by buy-side institutions. It will also set itself apart from venues such as Liquidnet Holdings by excluding everyone but long-term investors. Another difference: Luminex users must commit to a minimum trade, partly to avoid disappearing offers and other tricks. And even though trades take place anonymously, all parties on the system will be known to members.


By contrast, Liquidnet, whose average trade in the first quarter of this year was 43,000 shares, bars high-frequency traders in its main dark pool but has 13 so-called liquidity partners in the U.S. that participate through its separate Liquidnet H2O platform. “Liquidity partners can send an offer into the pool, and if the membership wants to interact with it, they can, but they don’t have to,” says Brennan Warble, the New York–based firm’s head of U.S. equities.


Luminex’s membership rules could limit its potential, Narang contends. “It remains to be seen how much flow gets done on this,” he says. “It’s been proven time and time again that the model of a buy-side aggregator adds very little liquidity.”


Many dark pools have found that this approach doesn’t yield much volume, so they end up asking trading firms to participate, Narang explains. The reason: Buy-side traders invest based on fundamentals, and they often have the same opinions on particular stocks. That makes it hard to match a buyer and seller, especially at the same price, Narang says. “To have a healthy, well-functioning market, you need a mix of players with a variety of time horizons and trading and investment styles so that shares can actually exchange hands.”


Still, Luminex appears to be filling a need. The idea for the platform was hatched two years ago at Fidelity Trading Ventures, which approached 18 major asset management firms that control about two thirds of all U.S. equity fund assets. “We talked with them about their pain points in sourcing equity block trades,” interim CEO Cashel recalls.


Everyone agreed that it’s gotten tougher to execute such trades, he notes. One obstacle for institutions: a fractured U.S. trading landscape consisting of 11 national securities exchanges along with 35 dark pools that accommodate block trading. Although improving technology helps buy-side investors navigate this terrain better, it doesn’t reduce the complexity of the marketplace. To make things worse, last December the average dark pool trade size was just 207 shares, according to Rosenblatt — half of what it was in early 2009. “It’s hard to find that liquidity right now,” Cashel says.


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Robert Stowe England is an author and financial journalist who has specialized in writing about financial institutions, financial markets, retirement income issues, and the financial impact of population aging.

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