Streaming Liquidity

Seth Merrin, the visionary founder of Liquidnet, is at it again. This time, Merrin, who launched Liquidnet in 2001, is hoping to fix the inefficiencies of the U.S. equity market with a new version of Liquidnet that brings in retail-size order flow to match against the existing wholesale liquidity pool.

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When he founded Liquidnet five years ago, CEO Seth Merrin envisioned an electronic marketplace in which the buy side could execute large blocks of stock anonymously at low cost without moving the market. Now that Merrin has accomplished that, and disrupted the status quo, he is ready to take on a bigger challenge - building a wholesale market for equities trading that intercepts retail-size order flow.

In an exclusive interview with Wall Street & Technology, Merrin laid out his plans for building the next phase of Liquidnet and fixing the U.S. equity market structure. The company's next big thing, which Merrin has spent a great deal of time devising, kicked off on Sept. 21 when Liquidnet began rolling out Liquidnet H2O, a new version of its buy-side-only matching system. Coincidentally - but perhaps foreshadowing H2O's success - Liquidnet had its first 60-million-share trading day on Sept. 21.

Unlike the original system, H2O pulls in streaming liquidity suppliers from a variety of sources, including direct-market-access (DMA) aggregators, ECNs, exchanges and agency brokers that have sliced and diced orders through their algorithms. Named after water - "the most plentiful resource on the planet," says Merrin - Liquidnet H2O, also known as Liquidnet version 3.0, brings in retail-size order flow to match against the existing wholesale liquidity pool in the Liquidnet platform. Merrin says the system aims to reverse what he sees as a problematic trend that finds wholesalers having to buy and sell their goods at retail stores.

"Rather than have the institutions go into a retail environment and try to satisfy the 250,000-share order at 400 shares a pop," he says, "imagine the power of having the 250,000 shares absorb a lot of those 400-, 300-, 200-share orders without putting pressure on the marketplace [and] without moving the marketplace." According to Merrin, the equity market then would mimic all other industries (except for securities), in which retailers buy and sell their goods at wholesalers.

Although Liquidnet has been working on the concept for the past two and a half years, it has been kept mostly under wraps. Initially, the firm is rolling out H2O to only about 20 buy-side firms because it wants to test the system thoroughly and make sure that all of the system's "moving parts" are working correctly, Merrin relates.

During the last two weeks in September and the second week in October, five Liquidnet members were given access to H2O and fewer than 1 million shares were executed "without incident." But the volume won't be significant until all the liquidity providers are on board, says a Liquidnet spokeswoman.

By catering exclusively to the buy side - including asset managers, mutual funds and pension plans - and policing the system to prevent gaming or information leakage, Liquidnet has built an enviable reputation for helping the buy-side community find the natural other side of trades. Liquidnet's Napster-like network reads all of the orders on buy-side firms' order management systems (OMSs), and, in October, there were 1.6 billion shares of buy and sell orders in the system on average each day. Further, the average trading volume on the platform climbed to 40 million shares a day in October.

The company clearly has expanded quickly since going live in April 2001 with 38 members. Today, there are 245 members live on the U.S. system, plus 44 members in Europe and two in Canada. Still - though Liquidnet has grown by leaps and bounds and experienced five 50-million-share trading days in September - it hasn't been able to find enough liquidity for the buy side.

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

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