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Liquidnet removes the barriers that erode trading performance, leaving members with seamless, efficient institutional-size executions. Members can easily access liquidity across 13 major markets through just one single access point.
Liquidnet, Inc. manages an electronic marketplace for institutional trading that brings buyers and sellers together and enables them to anonymously trade large blocks of stock without intermediaries or information leaks. Liquidnet's global community is comprised of many of the more prominent buy-side financial institutions in the world. The company boasts an industry-leading average execution size of almost 42,000 shares of small-, mid-, and large-cap stocks since its launch. Liquidnet is registered as a broker/dealer with the Securities and Exchange Commission (SEC) and is a member of the NASDAQ. Liquidnet Europe Limited is regulated by the U.K. Financial Services Authority and is a member of the London Stock Exchange. Liquidnet Canada Inc. is regulated by the Ontario Securities Commission and Market Regulation Services Inc. and is a member of the Investment Dealers Association of Canada.
2000-01: The Birth and Growth of an Alternative Trading System
Seth Merrin launched Liquidnet Inc. in April 2001 to bring together institutional buyers and sellers to trade large blocks of shares anonymously. After briefly considering a career in restaurant management, and having spent a year running a technology company in Silicon Valley, Merrin entered the training program at Oppenheimer Co. where he worked in the risk arbitrage group. As a risk arbitrage trader, Merrin worked closely with computer consultants to make it possible to spend less of his work time on manual tasks and more on trading. In 1985, at the age of 24, he founded Merrin Financial Inc., where, in 1987, he created the first order management system. Wall Street and Technology named Merrin one of the ten innovators of the decade for this development.
The year 1987 was a very tough one financially, Merrin recollected in a 2005 Pensions and Investments article. "At that point, nobody knew whether they were going to stay in business, and they certainly didn't want to hear from a 26-year-old kid that you could save them a few bucks. ... Going into 1990, we had all of nine clients ... not a raving success. But in 1990, the whole outlook changed, and people started investing money. In 1990, we signed 18 clients alone." In 1996, Merrin sold Merrin Financial to Automatic Data Processing Inc. where he continued to work for a couple of years.
Then, in 1998, Merrin quit the company. While still uncertain what he would do next, he came up with the idea for Liquidnet. "I had tried to figure out the solution to institutions' liquidity problems. ... The one missing piece that I couldn't figure out--nor could anybody else ... was how to create a critical mass of liquidity on day one. ... I was lying in bed one night, not particularly thinking of anything, but it was that Eureka! moment that the final piece of the came together. ... I drew everything out on a diagram. ... That was October 1999."
Merrin's diagram laid out a specialized virtual marketplace within the market, where only block traders were allowed to meet. The Liquidnet model integrated closely with online order management systems, which most large money management institutions by then used. It used the aggregate quantities of all customers' orders to inform participants when there was liquidity available for trade on the network. A computerized process that resembled a bridge allowed a trader to let others in the network know that he wished to buy or sell a block of a particular stock. Without identifying the trader, the system let other institutional traders know that somebody wished to make a deal. Traders could then show each other the size of their interest and their terms. For all deals struck, Liquidnet as broker, charged a commission of two cents per share.
Merrin took his idea to Eric LeGoff, who had run operations at Michael Price's Mutual Series from 1986 to 1996. LeGoff and Merrin had founded VIE Systems, a middleware software vendor where LeGoff served as CEO, in 1997. Merrin and LeGoff spent the next couple of months talking to "industry bigwigs," among them the chairmen of CIBC Oppenheimer and Neuberger & Berman, asking them to "blow holes" in their idea or join their board of directors. In February 2000, Liquidnet acquired Armonie Software, a venture backed technology start-up which sped the new company's time to market and distinguished its architecture from other alternative trading systems. In March 2000, Merrin and LeGoff raised their first round of venture capital, and little more than a year later, having planned, built, tested, sold, and installed their product, they were up and running.
Liquidnet's arrival came at a crucial time. As the average institutional order had soared to more than 250,000 shares, the average trade size on the NASDAQ had declined to 700 and on the New York Stock Exchange to somewhere between 1,000 and 1,200 shares. Block trades averaged 21,000 and 24,000, respectively. According to Barron's, no stock market has ever had the liquidity to absorb large block trades on the floor of its exchange. Posting a bid to buy 50,000 shares of even the biggest, most liquid stock is risky because of the large number of helpers entailed and the threat that the institution's intentions will leak out before the deal is complete.
Banks and mutual funds have tried two solutions, neither very satisfactory. They have engaged a large-block trader at a major brokerage to hunt down large-block sellers among his clients or through the worldwide rumor mill. They have also broken their order into relatively small retail pieces and fed the pieces into the market over time. On the way, they have encountered trade delays, missed trades, and market impact. Liquidnet, with its Internet-enhanced technology, promised to create institutional liquidity and eliminate the transaction costs of the standard system. Liquidnet also drastically undercut the traditional commission on institutional orders, which was about five cents a share on average, but with delayed and missed trades wound up closer to 45 cents on large-cap trades, and 81 cents on small-cap companies.
Liquidnet launched in April 2001 with about 38 institutions. First-day executed shares totaled 3,836,200 with an average execution size of 51,000. By the middle of May, 43 firms had signed on with 30 more committed, and the average trade was between 65,000 and 75,000 shares, somewhere around 90 times the industry average.
There was no cost to a member to sign on to Liquidnet, no service fee, no minimum commitment. All a company had to do was sign a two-page agreement, and Liquidnet arrived to do the half-hour software installation. For the most part, order management vendors facilitated their clients' integration process by constructing interfaces to Liquidnet's system, working with Liquidnet independent of their clients' involvement. In fact, by the end of 2000, Liquidnet had signed agreements with Advent Software, EZE Castle Software, and The MacGregor Group, three of the leading American order management system vendors, to couple their systems with Liquidnet's for those clients who wished to use its alternative trading system.
However some vendors refused to do so on the grounds that sell-side firms, which sometimes shopped orders around to their best customers, might be less inclined to assist an institution that no longer regarded the involvement of brokers as beneficial. In fact, they were skeptical of the whole Internet-based block trading option on the grounds that it precluded other firms from injecting bids and offers, a step, they argued, that could result in an improved price for the customer.
2002-05: Expansion in the European and Canadian Block Trading Markets
By April 2002, 89 institutions that collectively managed $4.3 trillion had joined Liquidnet. Of the nearly 16,000 trades that had been executed on the Liquidnet system, one out of every four had been for 100,000 shares or larger. By the end of 2002, with 125 members, Liquidnet ranked number one for large-block executions in both New York Stock Exchange (NYSE) and NASDAQ stocks. In November 2002, Liquidnet entered the European market with 33 participating firms in five distinct equity markets, the United Kingdom, France, Germany, Holland, and Switzerland, creating the possibility of cross border trading in Europe and the United States with a single broker, Liquidnet, instead of a broker for each separate market involved in a trade.
Liquidnet's membership grew steadily from its start. By the end of 2003, the online broker had 227 member institutions, representing 85 percent of the mutual fund industry, and was the 19th largest broker of NYSE shares. Collectively its membership managed the majority of equities in the United States (approximately $5.6 trillion) and included 62 percent of the top 50 buy-side firms.
Numbers continued to increase, and, in 2004, 271 institutions that collectively managed more than $6.6 trillion in assets had joined Liquidnet, now the 15th largest institutional broker of NYSE shares and the 17th largest for NASDAQ-listed stocks. Its average daily volume grew by more than 30 percent from 2003 to 2004, while NYSE's and NASDAQ's grew only 15 percent. The top-ranked broker for large trades, 50,000 shares or more, celebrated the good news when, in mid-2004, the Department of Labor's Division of Fiduciary Interpretations decided that Liquidnet could handle trades for Employee Retirement Income Security Act (ERISA) pension plans or their fiduciaries.
Liquidnet experienced further growth in 2004 as it launched Liquidnet Canada, Inc. in Ontario, a wholly owned subsidiary of parent Liquidnet Holdings, Inc. Inc. magazine named Liquidnet the fifth fastest growing private company in the United States based on its 10,406 percent growth from its inception. Head traders at 350 major money management firms voted the company one of the top ten institutional brokers in providing quality of execution for both NYSE and NASDAQ trades. By year's end, Liquidnet's average daily volume was 23 million shares, 77 percent greater than it had been just one year earlier.
The year 2005 saw five new European equity markets--Belgium, Denmark, Finland, Norway, and Sweden--join Liquidnet, by then the number one block trading firm in Europe. Institutional Investor magazine named Liquidnet its Leading Execution Venue as its liquidity pool topped 1.5 billion shares and the average daily volume traded set a new record at 33.3 million shares. From its launch in 2002 to 2005, Liquidnet's growth in principal traded in Europe had averaged more than 31 percent quarter-over-quarter.
By the end of 2005, Liquidnet had become the tenth largest NYSE institutional broker and the 11th largest NASDAQ broker. Fifty-two percent of the largest 100 U.S. buy-side institutions and 56 percent of the largest 50 companies (based on assets under management) were Liquidnet members. The company sold off a $250 million minority stake to two leading equity firms, Summit Partners and Technology Crossover Ventures, the proceeds of which went to some of its early investors. Estimates of the company's annual revenue were then around $145 million, not including its European business.
2005-06: Moving into the Wholesale Market for Equities
Merrin and company were getting ready to take on a bigger challenge: building a wholesale market for equities trading that would intercept retail-size order flow. In September 2005, with 245 members in the United States, 44 in Europe, and two in Canada, Liquidnet began rolling out Liquidnet H2O, a new version of its system, to about 20 buy-side firms. Like the original system, H2O pulled in liquidity suppliers from a variety of sources, expanding to include retail size orders. "Rather than have the institution go into a retail environment and try to satisfy the 250,000-share order at 400 shares a pop," Merrin explained in a 2005 Wall Street & Technology article, "imagine the power of having the 250,000 shares absorb a lot of those 400-, 300-, 200-share orders without putting pressure on the marketplace [and] without moving the marketplace."
The move to the sell-side was designed in large part to increase liquidity, which despite Liquidnet's growth in membership, was still in short supply. Ensuring adequate liquidity brought a slew of competitors, such as POSIT and Pipeline Trading Systems, looking to capture some of Liquidnet's volume, threatening to further fragment the institutional market for block trading. The idea behind H2O was that a buy-side trader, waiting to match a 250,000-share order in the traditional Liquidnet system, could trade with the "streaming liquidity" sources instead of leaving Liquidnet to search for another liquidity pool.
Industry analysts praised Liquidnet for maintaining its closed system while tapping into liquidity that had already been sent to the sell-side. Early results seemed promising as Liquidnet surpassed POSIT's volume in mid-2005. While still too early to determine whether or not H2O would prove as much of a splash as Liquidnet, it was certain that the company already had had an impact on Wall Street. While the NYSE was moving away from its human auction system toward a more electronic platform, NASDAQ announced steep price cuts for trades between its biggest-volume customers, from one-tenth to one-hundredth of a cent, and hiked the rebates it paid broker-dealers who brought in new business. Clearly Liquidnet had proved itself impressive competition for the old trading system and would continue to do so.
Liquidnet Canada Inc.; Liquidnet Europe, Ltd.
Archipelago Holdings, Inc.; E*Trade Financial Corporation; NASD; New York Stock Exchange, Inc.