“The Pipeline ATS is more efficient and allows firms to get the job done without tipping their hands,” says Fred Federspiel, Pipeline Trading System.
By Robert Daly, December 2003
Waters, Trading Technology Week

Institutional traders have been putting up with front-running and order-pennying for a long time and suffering in something less than silence every time traders and specialists get a whiff of their large block trades. Pricing decimalization was supposed to eliminate these under-handed practices by reducing their profitability from a six-and-a-half cent spread to a penny, but this has had the opposite effect, by reducing the amount of capital put to risk by the specialists and traders.

 Now, New York based Pipleline Trading Systems, a wholly owned subsidiary of e-Xchange Advantage Corp., plans to solve this problem of information leakage by launching its new alternative trading system (ATS). The new trading platform, dubbed the Pipeline ATS, will debut in the first quarter of next year, say Pipeline officials, and will provide traders with a way to execute large-block trades without being taken to the cleaners by specialists or predatory traders.

 According to Fred Federspiel, CEO of Pipeline Trading Systems, the new trading platform was designed from the ground up to prevent the leakage of information about large block orders. “It’s more efficient and allows firms to get the job done without tipping their hands,” he says.

 To create a leak-proof trading environment, the new platform uses a combination of proprietary block price range (BPR) calculations and pipeline firm interest (PFI) indications. The system uses the BPR, which it creates for each traded issue on the Pipeline system, to determine if an order, or a PFI, is seasonable priced and executable. These calculations are derived from a collection of various real-time quotes and are updated every minute.

 Individual traders set up a watch list of stocks and ETFs on their lightweight Pipeline ATS thin client or use their own order management system (OMS) that is connected to the Pipeline ATS via FIX connection. If an item on their watch list turns from gray to orange—Bingo!—there’s a counter-party looking for a large and reasonably priced quote in that issue. The traders won’t know if it’s a buy or sell order, just that there’s some large liquidity in that stock and now might be a good time to enter their own PFI into the system. Since the PFI is an executable order, it removes the typical gaming strategies that are commonly used with indication of interests (IOIs). Once the trade is completed the results are posted to the third market using NASDAQ ACT system.

 Similar to other institutionally targeted ATSs, such as Liquidnet, Nyfix Millennium, and Harborside+, the Pipeline ATS executes orders in real-time based on strict price-time priority. It also draws liquidity from the buy-side and sell-side firms, similar to other ATS platforms, such as Posit, NYFIX Millennium and Harborside+. “We don’t discriminate if it comes to the sell side,” jokes Federspiel.

 Where the Pipleline ATS moves away from the herd is with the minimum order size that traders will be able to submit. For most listed and OTC stocks, the system will accept a minimum 25,000 share block order. For the most liquid stocks, however, the minimum will be raised to blocks of 100,000 shares, which is approximately twice to four times the average entered order size on the existing ATS serving the institutional market and approximately 200 times the average order size on the New York Stock Exchange (NYSE).

 “We have no desire to prime the pump with thousand-share orders,” explains Pipeline’s Federspiel. “Such orders tip the trader’s hands to other traders using computer-based strategies that are common on other electronic systems. We avoid this by using large minimum order sizes. It gets rid of the sniffing behavior.”

The existing ATS players claim that they’ve already solved the information leakage issues with their own solutions and industry observers question if Pipeline’s new take on an old problem will be a viable selling point. The jury is still out at the moment on whether or not the new kid on the block will be able to succeed with its novel strategy. Many agree that there’s plenty of liquidity out there to spread among the various ATS platforms.

 “The major question is whether people will come to the new system.” Says Sang Lee, a research manager with industry analyst firm Celent Communications. “Is there a need for it? Yes there is, but there are needs for a lot of things and there’s a big difference between needs and reality.”

 The most important issue confronting the newly announced ATS Lee believes is its ability to guarantee enough committed liquidity to make it an attractive venue for the traders. “You may have the best technology out there,” says Lee. “But if you don’t have the liquidity, people wont come. If Pipeline was able to insure committed liquidity by getting, for example, ten of the twenty largest sell-side firms to commit somewhere between ten and fifteen percent of their large block orders through the system, Pipeline shouldn’t have a problem.”

 Although that may sound like a large amount of trading volume, many see it as a relatively small drop in the ocean. “The NYSE trades billions of shares a day,” says Michael Cashel, The COO of Hardorside+, who points out that even the largest ATS firms only trade tens of millions of shares on a daily basis. “This leaves plenty of room for new companies.”

 Likewise, the folks at Liquidnet aren’t losing sleep over the emergence of yet another ATS. “I don’t believe that the ATSs are cannibalizing each other for liquidity,” says Seth Merrin, CEO of Liquidnet. “If you look at the coverage in the business press, there’s a clear motive to move away from the current market structure. The only way to do that is through an ATS.” Merrin also believes that simply the promise of a large potential market mean that it’s going to be an easy task capturing it. “Last year, NASDAQ tried Liquidity Tracker to capture more institutional traffic. Instinet tried with its targeted orders and the NYSE tried its Institutional Express. All of the new systems introduced over the past 12 to 18 months have failed. That’s also not counting Optimark, the Arizona Exchange or the Midwest Match,” he says.

 “Firms are going to try to build this up as a cottage industry. Then it’s going to follow the same path that the ECNs did, with the smaller ones failing out. Eventually you’ll wind up with far fewer. At this point the market probably cannot handle another ATS. If they go after this market, it’s going to be an uphill battle,” he says.

 In spite of the challenges, Pipeline Trading, whose parent company e-Xchange Advantage Corp., has received funding from the BiosGroup, NASDAQ and Instinet, is moving forward with the launch of its system, says Federspiel. The company, which first developing the new system earlier this year, finished alpha testing the platform with 12 financial services firms in late summer and began its beta testing with an additional either companies in early autumn. The company has applied for SEC and NASD approval and is waiting for the regulatory organization’s response, which is expected by the first quarter of next year.

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