Rather than competing head-to-head with traditional exchanges, alternative trading venue Liquidnet is seeking to leverage bourses' client bases more actively.
The institutional buy-side platform has signed a letter of intent to share liquidity with an Asian exchange, and CEO Seth Merrin expects the deal to be finalised next year. He would not name the entity, but says Liquidnet is talking to the largest bourses in the region.
Market participants suggest that the Singapore Exchange is the most likely candidate, given its relative openness to new ideas. SGX did not confirm or deny by press time.
The agreement would not be an exclusive one in the region, says Merrin, who expects a second Asian partnership “to come on the heels of the first one” and a total of at least four such alliances worldwide next year. However, it's unlikely that Liquidnet would sign more than one tie-up per country in Asia, he adds.
Liquidnet struck a similar partnership in January with Six Swiss Exchange – the first agreement of its type between a traditional exchange and a dark-pool operator. “We bring massive liquidity from outside Switzerland and they do the same from within Switzerland,” Merrin told AsianInvestor during a trip to Asia in late October.
These kinds of tie-ups create more business for exchanges, he adds, suggesting that traditional bourses should “go back to their routes in terms of being focal points [for liquidity]”.
Now more than ever exchanges must look beyond their borders for revenues, says Merrin. And that is particularly true of Asian bourses, given their relatively small size in global terms: the combined volume of all Asia-Pacific exchanges equates to just 25% of US exchanges' volume.
Meanwhile, Liquidnet is planning to roll out globally more of the services it offers in the US, including managing more of its members’ order flow and moving to seek additional dark liquidity from brokers and other platforms by opening the platform to more exchanges and brokers.
This will require Liquidnet keeping a close watch on which external flow its members are being exposed to. The platform can do so by, for instance, mandating a minimum order size for all external flow to ensure high-frequency traders don’t enter the pool, or examining all flow for adverse selection and adverse price movements.
While market participants agree this is an issue, a senior trader at a long-only fund manager in Hong Kong says: "I’m not sure how the market will view a Liquidnet tie-up with an established exchange. The reason many institutions use Liquidnet is because they are buy-side to buy-side and don’t have brokers' flow. If they open up to an exchange, the quality of flow may suffer."
Still, lack of liquidity is possibly the biggest issue traders face these days, and regulators are concerned about the fragmentation of liquidity among broker pools, says Merrin. A few broker pools may be fine, he adds, but 40 would be a problem. “We want to see that liquidity go back onto the exchanges.”
Separately, Liquidnet is seeking to exploit opportunities in smaller, less developed Asian markets, such as those in Southeast Asia. For example, there is huge external demand for assets in Indonesia and Malaysia, says Merrin.
He cites the example of a recent trade that took place in Indonesia, which was the equivalent of two years’ average daily volume (ADV) on the Jakarta exchange – about 45,000% of average daily volume (trailing 10 days) was done in a single cross. Merrin did not name the stock, but sources say it was telecoms tower company Sarana Menara Nusantara.
Liquidnet only started providing Indonesian liquidity last year and in Malaysia at the end of 2010. Its average execution size in the year to the end of October in Indonesia was $1.15 million (56% of the Jakarta stock exchange's ADV, while in Malaysia it was $1.38 million (28% of ADV).
Thailand has said it is happy to invite alternative trading systems into the market, says Merrin, but the question is whether the market is big enough to take multiple venues at present.
“If the opportunity is big enough and the market is open enough, someone will have a go,” he says. “It will be economy-driven rather than by market forces or competition.”