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Crossing Over

Brokers are transforming their internal crossing networks into alternative trading systems to boost their match rates and earn market data revenues.

Large brokerage firms that have huge amounts of natural liquidity from customers flowing through their trading desks are offering buy-side traders the ability to cross their trades internally. In some cases, brokers are registering their internal crossing networks as alternative trading systems (ATSs) to make these networks more attractive to the buy side by bringing in regulatory oversight and opening them up to external sources of liquidity.

"Really, what they're doing is crossing natural flow," observes Robert Gauvain, director of U.S. trading at Pioneer Investments. "They're putting together at a midpoint [price] buyers and sellers." Natural flow is the stream of buy and sell orders that institutional and/or retail customers route through the sell-side trading desks, DMA platforms or algorithmic strategies. Internal crossing enables brokers to potentially match both sides of trades within their own shops.

So far, Credit Suisse and Goldman Sachs Execution and Clearing Services (GSEC) have registered ATSs. Morgan Stanley also is building a new crossing network and intends to file as an ATS. And there is speculation that more brokers will enter the ATS game. "The big players all have [crossing networks] already," says Alex Ramistella, an analyst in TowerGroup's securities and capital markets practice. [Ed. Note: Ramistella left the company at press time.] "It's a matter of how they are going to use them and if they are going to externalize it."

Morgan Stanley, for example, is developing an internal crossing network to augment the crossing that it currently does with algorithmic orders. "The goal is to create an internal crossing network for all order flow," relates Brian Fagen, the firm's managing director, institutional equities division. "Right now, they just cross algorithmic orders internally and electronically," he comments. But the firm is considering expanding its crossing activities to factor in smart order routing, direct market access (DMA) and orders that are being routed to the New York Stock Exchange's DOT (designated order turnaround) system. "Why couldn't these [orders] all be internally crossed?" suggests Fagen.

Sell-side firms say the advantage of these internal crossing networks is that they obtain the best price and incur less market impact than if orders were routed externally to exchanges and ECNs. "They may be buying at the bid or meeting in the middle when they're crossing," says Larry Leibowitz, managing director and COO of UBS Equities Americas, which manages more than 350 million shares a day of institutional and retail flow. "They're typically not going to be paying the spread."

Beyond the obvious spread savings, the liquidity provided by sell-side crossing networks offers the buy side "a lower-impact way of trading, because these orders have the opportunity to trade with other natural liquidity directly in addition to participating actively in the market," Leibowitz adds.

Unlike exchanges and ECNs, which display their quotes, crossing networks' quotes are not displayed and, therefore, offer anonymity, so there is less chance of information leakage. Because the crossing networks are not displaying a quote in the public market, they may not have as much impact as they would if the order was routed to an exchange or ECN, industry participants say. Further, internal crossing networks allow brokers to find matches without paying fees to exchanges and ECNs.

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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