Aqua Paddles to Undiscovered Streams of Liquidity Flowing Anonymously From Mid-Tier Broker-Dealers

Originally published January 21, 2008

The now-familiar competition to tap dark liquidity and transact large block trades has matured to the point where all a service provider or trading venue can offer is a better mousetrap, not necessarily any new mice to catch. A new equities venture by Cantor Fitzgerald and eSpeed, called Aqua Securities, is showing potential users that there are indeed undiscovered streams of liquidity to be tapped, largely from mid-tier regional broker-dealers. After about 12 to 18 months of preparation, Aqua, 51 percent owned by Cantor and 49 percent by eSpeed, has its system operational and has about 12 firms in production, with buy-side users due to come on board this month. Global Investment Technology spoke with Kevin Foley, President and Chief Executive Officer of Aqua, whose experience includes a leadership role at Bloomberg Tradebook.

GIT: What have been the challenges and successes of your first year as President and Chief Executive Officer of Aqua?

KF: We’ve gotten an extraordinarily high number of firms to agree to participate in Aqua, so we’re really happy about that. Of all the things I’ve sold in my career, this has been the best received of anything. So we’re very optimistic about the coming year. Despite many billions of dollars spent on trading technology in the past decade, there is widespread dissatisfaction with block liquidity. It seems that the reason for that is the success of algorithmic trading. A portfolio manager who wants to own a stock with urgency cannot understand why it takes the trader two weeks. The reason is that the other side of the trade is in some algorithm someplace. It used to be you could find each other and one [party] might be in a hurry and the other might not be, but the one who wasn’t in a hurry would at least take advantage of the opportunity for a good execution because there was an urgent buyer. Now they have a more difficult time finding each other — at least that’s the consistent complaint you hear about being able to get blocks done. The algorithms have changed everything. There’s no block liquidity on the floor anymore.

The other thing that seems pretty clear from conversations we had with buy and sell side traders, starting in mid-2006 through most of 2007, is that people are sick of new technology. They just don’t want it. They don’t want to learn anything new. They’ve been there and done that. But one thing is motivating to just about everyone you talk to.

That’s access to new liquidity. People won’t take your product because it’s new. That’s actually a negative. To be motivating, you must have liquidity they don’t have access to.

GIT: How would you describe your business model?

KF: Think of it like the airline industry. We found some routes that are under-served and we’re providing direct flights between large institutions and medium-size brokers. The heavily traveled routes between the big sell-side and the big buy-side firms are very well served. Liquidnet is doing a terrific job serving the buy-side to buy-side route. If we came in and promised to fly on a route that’s already served, people would just not be interested — maybe in the abstract they think competition is a good thing, but they’re not going to take your product. They used to be able to go through hubs such as Instinet, just like flyers go through hub cities. Now the trading is like having to change planes too many times. But if we fly routes that they need to fly and right now are not served, they will use us. We plug a gap that’s not being served anymore by the old traditional methods for finding block liquidity.

GIT: What is unique about Aqua’s value proposition for block trading?

KF: First of all, it’s new block liquidity that you aren’t currently seeing. If you’re a large institutional investor, [Aqua offers] block liquidity from brokers in a form that you’re not seeing, and a level of convenience and safety that’s frankly unprecedented. For the sell side, it’s access directly into the block liquidity on the desktops of the largest institutional investors. We all know that liquidity begets liquidity, but Liquidnet excludes brokers, and there’s a lot of buy-side order flow that gets worked by brokers as agents. That is our opportunity. We wouldn’t compete against Liquidnet, because there’s no problem transacting between buy-side firms. We started asking what it would take to bring the convenience and simplicity to broker order flow that Liquidnet delivered to the buy-side order flow. The answer came back pretty clearly — it just can’t be a negotiation.

In the all-buy-side model, they’re all friendlies, so negotiation works; but a negotiation has a lot of potential for information leakage before you ever get a trade done, because you find out about each other. You don’t want to do that with just anyone. We suggested that brokers start at the endpoint, with their last, best, final bid or offer. This would mean it had to be firm and executable. They have to be aggressively priced, because they only get one shot at it. It’s a system where the buy side can’t counter — if you’re off by a few pennies, you’re just giving away information for nothing, because if you don’t show a bid that’s aggressive enough, the buy side guy won’t hit it.

Lastly, it has to be blindly submitted. Buy-side people told us that brokers could not know that they were seeing the bids and offers, and that brokers could not know if someone is there with the contra order. We only show it to a natural that has a contra order, and we don’t say whether we did so. The buy-side user doesn’t learn the name of the broker unless the broker decides to advertise the trade.

GIT: How does Aqua’s model differ from Pipeline or BIDS?

KF: It couldn’t be more different in the anonymity and the way we handle information leakage. Aqua is an improbably good deal for the buy side because Aqua is the first and only system for the buy side where there is absolutely zero pre-trade leakage, zero information leakage. They’re free looks. No one ever knows you’re there. They’re aggressively priced. It has to be the midpoint or better, or we’ll never show it. It has to be really large.

GIT: Do you sense a resurgence in block trading? Is the pendulum swinging the other way now?

KF: I don’t think it’s so much the pendulum swinging back the other way as it is the demise of block trading being prematurely reported. It’s a similar thing with small and mid-tier broker trading desks. Next year, you will probably hear about the pendulum having swung back, but the answer is that block trading hasn’t died. Commission sharing agreements have not chilled the demand for diversity of execution methods and venues. From what we can see, there’s plenty of demand for trading with regional, mid-tier and smaller brokers. Some of the traditional ways of laying off positions have deteriorated and new ways like Aqua have emerged. Changes in technology just continuously make new things possible. The buy side didn’t migrate to vendor order management systems so a system like Aqua could provide a service to them. They did it to manage their workflow. But having done that, that work could be harnessed to improve their access to liquidity. You continue to see the discovery and exploration of unexpected and unintended benefits to the investments people have made in technology.

GIT: Does Aqua have an European counterpart or plans to enter that market?

KF: We will. We’ll follow the growth model we followed at Bloomberg Tradebook, which is getting traction for US participants for US equities, and then in 2008, introduce US equities to European participants. Then when we have enough European participants trading US equities that they could trade with each other, we’ll introduce European equities to them. That will probably be 2009 for us to shoot to go for Europe and Asia.

GIT: What may be the next new big things following the innovations of direct market access and algorithmic trading?

KF: What we’re doing is pretty radically different but not in how difficult it is, but rather in how simple it is. While everyone else is scrambling with really smart people to come up with an algorithm that’s better than all the others, which at this point has to be a job for only the smartest, to some extent we have an advantage in not needing to be the smartest. While others are scanning buy-side order blotters to compare them to each other and find matches, our technology is far less intrusive and gets to be less intrusive because we don’t do that. 

We came up with a model that we call ‘Go fish,’ because whenever we want to qualify you as to whether you can see an order, we have a specific question. We never say, ‘Show me everything in your hand.’ We re-query your blotter as to whether you have the other side of the order. If the answer is ‘No,’ the question was encrypted. That’s the integration work we do with OMS vendors, so we can put a copy of the order in a place where we can ask an encrypted question. If the answer is ‘No,’ you don’t know what your system just said no to. That’s how we protect the safety and security of the broker who’s given us this order. We just don’t tell the broker whether there’s anyone who qualified for it or not. So the buy side person gets an entirely free look and the sell side person gets an unprecedented level of security. Before, that type of narrowcasting was only available buy-side to buy-side.

GIT: You are particularly aiming at the regional, mid-tier sell side firms, giving them a platform to showcase their orders?

KF: That’s right. It’s not that we’re excluding the bulge-bracket firms. We’re going to people who are just happier to see us. They had a liquidity problem that’s more acute than the bulge bracket firms. We help address that problem. Certainly the bulge bracket, rightfully so, has a lot of confidence in their ability to get things done for themselves. They do so much for the buy side already that mentioning the name of a bulge-bracket firm doesn’t motivate a buy-side firm to use us. We need to focus on the reason why someone would take our product. If and when Aqua is being used by their customers, the big sell-side firms may find they want to participate.


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