Fidessa to Bring Fragulator to U.S. Markets

While the SEC’s proposals for increasing transparency in dark pools have stirred up industry debate, there could be a technological solution to the U.S. problem that hails from Europe.

Fidessa, plc is planning to bring its Fragulator to U.S. equity markets. The Fragulator is a software application that shows the breakdown between lit and dark pools for each stock based on its trade reports.

Fidessa launched the Fragulator in Europe last October in response to the proliferation of multilateral trading facilities or MTFs under the Markets in Financial Instruments Directive (MiFID), which has resulted in fragmentation of liquidity across the Pan-European exchanges and alternative trading venues.

“One of the objectives we set out is to produce a consistent, uniform way of measuring market share across all the MTFs and primaries,” explains Steve Grob, director of strategy at Fidessa in London. Fidessa has been providing the service free-of-charge to serve the institutional trading community. “We’ve got thousands of beta testers (in Europe) and we imagine doing something similar in the U.S.,” says Grob.

Fragulator runs on Amazon.com’s S3 (Simple Storage Service) cloud technology delivered through cloud computing over the Internet. “We have a database that sits in the middle of this cloud, reaching out to every European venue,” says Grob. “Fragulator is pulling data from more than 40 venues in Europe. It aggregates, normalizes and analyzes all of the data reported by dark pools, systematic internalizers (a.k.a. market makers) and lit venues to the various trade reporting facilities.”

Unlike the U.S., where dark pool trades are reported via the FINRA/NYSE Euronext or FINRA/Nasdaq trading reporting facilities or the Alternative Display Facility, the guidelines under MiFID allow brokers to report their trades to multiple trading reporting facilities. “A broker’s dark pool can decide to which trade reporting facility they report their dark pool trades to, whether that’s as a systematic internalizer, as an OTC market or as a dark pool. In the past, the London Stock Exchange was a dominant trade reporting facility, but under MiFID there are other choices, so that LSE competes against Boat, Plus Markets, Chi-X and any other venues,” explains Grob.

Complicating matters further, under MiFID, Europe doesn’t have a single post-trade consolidated tape, so each venue acts as a reporting destination for the other venues. For instance, Chi-X has an OTC reporting feed. Instinet’s BlockMatch uses Chi-X as its reporting destination, which comes out of Chi-X’s OTC feed, notes Grob. During the same trading day, brokers could report different trades to multiple venues. “Each dark pool could report trades to Boat, London Stock Exchange, Chi-X, or even to the Athens Stock Exchange and to the Warsaw Stock Exchange,” illustrates Grob.

“The level of dark pool activity is being vastly underestimated because of the way it’s reported,” contends Grob. While not suggesting that anything deliberate is going on in Europe to hide information, Grob says, “The problem is it’s very hard to get accurate information about what’s going on. It gets even more confusing because some of the broker dark pools in Europe such as Nomura with NX, Instinet with Block Match, and ICAP with Block Cross, report as MTFs, while others report either as systematic integrators or OTC. However, recently, Nomura with NX and UBS MTF, registered their dark pools as MTFs, which means they have transparency reporting requirements.”

In mapping out the strategy for the U.S., Grob has been talking to brokers that operate dark pools. So far, the reaction has been positive, says Grob.

“They’re seeing just how prevalent the Fragulator and FFI has been across Europe,” he says, referring to brokers and buy-side firms that already utilize the Fidessa Fragmentation Index (FFI), an unbiased measure for tracking the top 20 most fragmented stocks across European venues.

Launched in November 2008, the FFI tells someone the average number of venues they should visit to achieve best execution. If a stock has an FFI of one, it means the stock is trading in the primary market, but once the FFI is two it means the stock’s volume is fragmented across two venues.

Part of the reason for lack of visibility in the U.S., is that brokers report their trades as over-the-counter or OTC. However, in a rule proposal filed in November of 2009, the SEC suggested that brokers reveal the identity of their dark pools in real time on their trade reports. After reviewing comment letters from the industry, the SEC is expected to reach a decision this spring.

One of the important distinctions Fragulator could make is whether they are crossing two client orders in a dark pool or whether the operator of the dark pool, such as GETCO or Knight, is always on the other side of the trade, says Grob.

Since the SEC proposals for dark pool transparency are pending, Grob couldn’t provide details on how Fragulator would work in the U.S. “It will depend upon what the SEC is going to decide to do and it seems unlikely that they are going to do nothing at all,” says Grob.

Secondly, Fragulator’s success in the U.S. will also depend on market participation. As he’s circulated the idea of bringing Fragulator to both the U.S. and Canada, early indications are that brokers would rather be involved than not be involved, says Grob.

Regardless of which way the SEC rules, Grob says there will be best practice. “People would rather be involved than not involved,” says Grob, noting that firms like Nomura can use the Fragulator to show the market share that NX has in stocks. “That’s very powerful from a neutral source.”

Ivy is Editor-at-Large for Advanced Trading and Wall Street & Technology. Ivy is responsible for writing in-depth feature articles, daily blogs and news articles with a focus on automated trading in the capital markets. As an industry expert, Ivy has reported on a myriad ... View Full Bio