There are 15 American securities exchanges registered with the SEC and more than 50 dark pools currently operating. So why would a consortium of asset managers that collectively manages 40 percent of U.S. assets create yet another ATS?
Luminex, a new trading venue formed by Fidelity along with eight other firms, hopes to begin operating by the third quarter of 2015. Just don’t call it a dark pool. “Luminex is a dark pool with the lights on,” said a consultant working with the new trading venue. The founders’ intention is transparency: a confidential, cost-effective venue for large block trades. Also, it won’t be operating for profit. “Luminex will fix what is broken in this sliver of the market and benefit the end fund-owner” by passing along the lower cost of its trades, said the consultant.
The firms behind Luminex are a who’s who of buyside giants. Along with Fidelity, the other backers include BNY Mellon, BlackRock, Capital Group, Fidelity Investments, Invesco, J.P. Morgan Asset Management, MFS Investment Management, State Street Global Advisors and T. Rowe Price.
Post-Reg NMS, the number of trading venues has exploded, electronic trading has dramatically increased speed, and market-makers have embraced HFT. The process of trading has frequently become a multi-step process where one transaction will be preceded by 10 trading gestures to gauge the market, with information leaking along the way. One often-noted trend has been the decrease in the size of trades in dark pools. Block trades typically get shredded into an average size of 187 shares. This is actually smaller than the 200-share average size of a trade on the exchanges.
SEC Commissioner Mary Jo White listed market structure as a primary issue for 2015, including the lack of transparency in dark pools, and has a preference for market-driven solutions. To that end, Luminex will have transparent trading protocols and rules; members will be treated equally, and must agree to have their participation in the venue publicly disclosed.
Trades will have a minimum of 5,000 shares or $100,000. There will be no shredding of orders. When a match is found, execution is guaranteed. There’s no falling down on trades, so testing the market will be eliminated. Once there is a match, traders can size up. The structure intentionally returns to a more straightforward trading process that was fragmented by Reg NMS.
One source described the frustrations inherent in the way the present system functions. “If you are a large asset manager and you have a large block of shares, and you bring it to a dark pool and it gets immediately shredded up, into thousands of high-frequency trades that fall down and expose your interest, that is a real problem. If you take your 5,000-block share to Luminex, nobody can take a peek at your interest, go somewhere else and move against it, or send in hundreds of orders at various prices.”
Luminex will allow only long-oriented firms to trade – hedge funds will be welcome but not HFTs. Decisions on what constitutes an acceptably long-oriented firm will be made on a case-by-case basis. One observer commented that Capital, a consortium member, certainly places plenty of short trades.
Update: A representative from The Capital Group said it does not have any funds or clients that currently engage in short selling.
Luminex does not see itself as a competitor to IEX, the buyside pool that hopes to become a buyside exchange. “IEX has its own business model, and this isn’t about competing against any particular pool,” said Stephen Austin from Fidelity. Luminex sees itself as a utility. “The goal is to generate enough business to operate at cost. They will retain no profit at the equity-owner level.”
CEO Michael Cashel noted that Luminex seeks to pinpoint what is not working and correct it. “We did a lot of research with the asset management community,” he said. “One of the specific pain points mentioned was the frustration traders have when trades fall down. Within Luminex, when you place an order, you are committing to making a trade if there is a counterparty and both of your orders are marketable.”
Cashel is aware there may be bumps in the road: “We’ve now spoken to more than 175 market participants, most of whom who have expressed interest in trading on the platform. We recognize the challenge of having a critical mass of liquidity, and it is one of the biggest challenges that we face, but we’re optimistic.”
