To U.S. dark-pool operators, the development of an exclusive managers-only trading venue, Luminex Trading & Analytics LLC, is a splash of cold water on the face of an industry that some managers believe has taken institutional investors for granted.
Luminex, a U.S. equity dark pool run by nine large money managers set to start operations later this year, “is an effort that in many respects reflects a response to institutional investors who don't feel well treated by exchanges and dark pools,” said Jamie Selway, managing director and head of electronic brokerage at Investment Technology Group Inc., a New York dark-pool operator and financial markets technology provider. Mr. Selway said an ongoing lawsuit against dark-pool operator Barclays PLC, fines levied against UBS Group for failing to follow best-execution rules — even the backlash from the Michael Lewis book “Flash Boys,” about high-frequency trading manipulation — all have led money managers to look at executing large-block trades themselves.
“Look at the 'Flash Boys' allegations, the (lawsuits and fines), you can just keep going,” Mr. Selway said. “The feeling is that they can take matters into their own hands and do a better job of trading.”
Mr. Selway said asset owners played an important role in pressuring the nine members of Luminex — Fidelity Investments, Bank of New York Mellon Corp., BlackRock Inc., Capital Group Cos. Inc., Invesco Ltd., J.P. Morgan Asset Management, MFS Investment Management, State Street Global Advisors and T. Rowe Price Group Inc. — to create their own trading venue.
“I've heard from many senior investment people (at money managers),” Mr. Selway said. “When they get calls about 'Flash Boys' and what they're doing about (high-frequency trading), and (managers) say they're talking to their broker-dealers, looking at their operations — it all sounds very passive to the asset owners. It speaks to the level of frustration of managers and asset owners and in how managers have to answer for this.”
The debut of a manager-operated dark pool also speaks to what Adam Sussman of Liquidnet Inc. sees as an evolution in trading. “There's been a long-running trend of a blurring of the lines between exchanges and brokers,” said Mr. Sussman, senior adviser, head of market structure and liquidity partnerships at Liquidnet, a New York dark-pool operator. “From a 30,000-foot perspective, the next logical evolution is the blurring of the lines between broker-dealers and asset managers. Asset managers see trade execution as a very important part of the process, so why not own the process? There are a lot of efficiencies in asset managers doing it themselves, so to me it's a logical endpoint.”
Mr. Sussman said he thinks the managers' actions are more a response to what they see as an overall market structure problem, including lit exchanges, and not just pinning the blame on dark pools.
“Asset managers do look at today's market structure,” Mr. Sussman said. “A number of them have been calling for some kind of market structure reform. It seems that this is an example of managers putting their money where their mouths are. But with those managers, it's not just about dark pools, it's also about order types, for-profit exchanges. It's the whole market reform movement,” including the Securities and Exchange Commission's creation of an equity market structure advisory committee, which will study the structure and operations of the U.S. equities markets.
“I don't think Luminex has any particular dark pool in mind,” Mr. Sussman said. “They just want to trade more efficiently. They're not after any dark pool in particular.”
Added Mr. Selway: “We (at ITG) think we're doing a good job, but obviously we also think their message is that they want us to uptick our game. It's not just with dark pools, it's just that managers aren't happy with the industry, and I think that's reasonable.”
Among things dark pools can do is improve how they conduct block trades, which is a big issue for money managers and asset owners because of the high volume of trades they make. “Block crossing is very hard,” Mr. Selway said. “We do a good job (at ITG), but that doesn't mean we can't do better. There's no end to the work you can do to improve what we do. ITG, Liquidnet, all of us are close to what the buy side wants, but we can always do better.”
Among the improvements necessary: transparency, best execution and accountability — all things Mr. Sussman said “dark pools are already doing.”
“I think more transparency is a big thing,” Mr. Selway added. “We put a lot of our data out in the public domain; others do, too. The industry has to continue to do more of that. And Luminex will be handling large block crosses; exchanges and dark pools need to improve their block trading system so that the performance rate is better, so there's less chance of a trade not getting consummated. And the buy side wants us to be more dedicated to best execution. Venues don't always have the incentive to do best execution.”
Luminex's development doesn't necessarily mean other managers will follow suit and develop their own trading venues or ask to join Luminex. Mr. Sussman said that, were he a money manager, “I'd want to see what happens next, where does Luminex go next. There are nine asset managers signed up for this; I think it would make sense for other folks to see what happens to the nine.”
Mr. Selway also said it's important not to minimize what Luminex means to other exchanges. “I definitely think it's a wake-up call,” Mr. Selway said. “When some of your most informed and best customers decide it's better for them to become brokers themselves, you really need to look at what you're doing and how you can improve.”