AT: Could you tell us about Liquidnet's origins?
John: About 12 years ago, Liquidnet was founded on a premise that institutional investors, traditional buy-and-hold investors, have very particular needs that - back then and still today - are not well met by the market at large. Seth Merrin, our founder and CEO, had the notion that if we created a community of like-minded and similar-profile institutional investors they would have the opportunity to interact directly with one another and be able to trade in the very large-scale blocks, and to do so in a way that enables portfolio managers and traders to capture the maximum returns in their portfolios. 12 years on, there are perhaps as many as 50 dark pools around the world, and yet no one has a model likes ours, which is buy side only. And what I find as I've gone out and met our members is that the core value proposition of Liquidnet is reinforced over and over again.
AT: By having a members-only policy you are, by definition, to some extent cutting off some sources of liquidity. So it's always been the business model to keep it that way?
John: When our members log in in the morning they allow us to see all of their intentions for the day from their blotter. And based on those indications, we find other members - we have over 750 institutions around the world who manage approximately $13 trillion of equity assets under management - to match up those indications. It provides the opportunity for two traders to contact one another directly and anonymously through their workstation and negotiate a transaction, or not. If, for whatever reason, they chose not to trade in the Liquidnet system, obviously they can go outside and trade anywhere in the market that they like. But the power of the Liquidnet model is that, given this global presence that we have with this large community of investors, it is in fact the largest and deepest pool of natural liquidity to be found anywhere.
AT: In that sense, is a lot of this activity automated?
John: First, our members start out their day by sharing anonymously in our system their intentions for buying or selling securities. There is this exceptional level of trust that's required for an institution to tell you what he intends to do before creating an order. Second, by sharing those indications, it creates the opportunity for two individual traders to negotiate directly. It's two people who decide to interact while maintaining anonymity and they are interacting with the confidence that it is another buy side firm just like them.
The second thing that can happen is if you have, for example, 800,000 shares of stock that you are looking to cross, you may find that you've crossed 780,000 shares of that 800,000 and you have 20,000 shares left to go. Our members can then finish their large order by using one of our quantitative trading strategies, an algorithm, to finish the order that they started through that manual negotiation. Those algorithms are distinct from the rest of the market, first and foremost because they are still available to interact with our members-only pure buy side natural pool. The other thing about our quantitative strategies is that a member can, at their choosing, decide to send that order to the external market, and through our algorithms, they can then access liquidity from the sell side or in some cases directly through members of a stock exchange.
AT: All of that brings up a couple of questions. The share of those left-over trades, what is the ratio of those and the negotiated, manual trade that takes place and what is the trend there? Also, within that sub-set, how much of that stays in the member community and how much of that goes externally to widen the sources of liquidity?
John: 75 percent of all trades are negotiated manually member-to-member and about 25 percent are orders that are executed through one of our algorithms. Some of our algorithms are designed to interact only within our natural pool while others interact simultaneously with our natural pool, the member community, and at the same time, with external liquidity outside our community. And then lastly, there are some algorithms that are designed to interact only with liquidity that we access outside of our pool.
AT: But you see a fair share in all three of those categories?
John: It floats around.
AT: How would you characterise the algos you provide?
John: Our algos are a fairly representative sample of the traditional eight or nine most typical categories of algorithm. So, the general volume-weighted average price category, implementation shortfall, percent participation over the course of the day.
AT: Do pretty much all the members, or most of the members, use those algos?
John: I can tell you it's fairly broadly the case that our members use algos to create orders, clean up residuals and interact with the street.
AT: On a broader level, what are some of the trends within the member community in terms of types of new members coming on board, the kinds of trading opportunities they are interested in?
John: Our members are among the most sophisticated institutional investors anywhere in the world and they are constantly seeking opportunities to deploy capital where returns are most attractive anywhere in the world. So as a result, we have built, over several years, the ability to execute large-scale block transactions in 41 markets around the world. The most recent markets that we have opened up include the Philippines and Turkey.
In addition to being able to execute very large blocks, among all the developed economies and major exchanges, we have far and away the largest, broadest capacity to do buy-side-to-buy-side block trading in emerging markets, whether it be the eastern bloc countries of the continent or Southeast Asia or anywhere in the world. That's clearly one of the biggest trends that we've seen over the last several years.