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Block trading reduces information leakage – Liquidnet study
(pictured: Tristan Baldwin)
by John Kavanagh*
Block trades have a significant mitigating effect on stock price volatility in the minutes leading up to the execution of a large share transaction, according to new research.
Block trade specialist Liquidnet analysed its trading activity during the first half of the year and found that stock price volatility on trades put through by other brokers was 103 per cent higher in the minute prior to execution.
Tristan Baldwin, the head of Liquidnet Australia, says pre-trade price volatility is a sign of information leakage, which can have an impact on returns.
“If an investor is looking to buy a large block of shares and the price rises immediately prior to dealing, alpha will suffer,” Baldwin says.
“We are operating in a low return environment. The industry is looking at its fees and at processes that can add alpha.”
Liquidnet’s study was based on 31,779 block trades conducted between January 1 and June 30 this year, with a minimum transaction size of $200,000.
Liquidnet was launched in the United States in 2001 and in Australia in 2008. In the local market it operates as an equities-only block trading platform.
A block trade is a privately negotiated transaction, forming part of the “dark market”. The Australian Securities and Investments Commission requires that for a block trade to be “done at any price” there must be a minimum transaction size, depending on the liquidity of the security: $1 million for large caps; $500,000 for small caps; and $200,000 for micro caps.
ASIC reviewed dark trading in 2012 and produced a report in May 2013, which said the growth in dark trading had led to a widening of bid-offer spreads on “lit” exchanges, such as the Australian Securities Exchange.
It said there was evidence that the quality of price formation had been adversely affected in securities with high levels of dark trading below block size.
It was also concerned that dark pool operators had conflicts of interest, such as trading with clients against their own accounts. It found that clients had limited visibility of the way “crossing systems” operated.
The regulator made a number of changes to rules covering minimum thresholds, transparency and disclosure, conflict management and fairness.
Last year ASIC conducted a follow-up review of dark trading, in which it concluded that: “current levels of high-frequency trading and dark liquidity are not adversely affecting the function of Australian markets for businesses and investors”.
ASIC estimates that dark trading makes up 25 to 30 per cent of total equity market turnover.
Baldwin says large block trades make up about half of that activity. Liquidnet’s average trade size is $1.5 million.
He says information leakage is not possible on a block trading platform. “It is a black box. Our people can’t look at what participants are doing and participants can’t look at each other.”
*John Kavanagh is editor of Banking Day
