aite-alt execution sep2006

7/28/2019 Aite-Alt Execution Sep2006

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Sang Lee

[email protected]

10 High Street

Suite 905

Boston, MA 02110

Tel: 617.338.6050

Fax: 617.338.6078

[email protected]

IMPACT NOTE

Actionable, strategic advice on IT, business, and regulatory issues in the financial services industrywww.aitegroup.com

T H E U . S . E Q U I T I E S M A R K E T

I N T R A N S I T I O N :A L T E R N A T I V E E X E C U T I O N V E N U E S

I N T R O D U C T I O N

Competition and fragmentation are two words that can be used to aptly describe

the current state of affairs in the U.S. exchange market. While the two largest

pools of liquidity continue to seek global dominance, the domestic U.S. equities

market remains largely fragmented, at least on the surface. However, it would be a

mistake to equate increasing competition with market fragmentation. When

examined closely, the U.S. equities market is still dominated by the New York Stock

Exchange (NYSE) and NASDAQ. According to an Aite Group analysis, as of Q2

2006, the NYSE Group and NASDAQ collectively account for 78% of the entire U.S.

equities market (see Figure 1 on page 1). By Aite Groups estimation, there are

over 20 other execution venues that are battling for the remaining 22% of the U.S.

equities market share.

FIGURE 1: U.S. EQUITIES MARKET SHARE -- Q2 2006

Exchanges, ECNs, ATSs, Brokers, Aite Group estimates

U.S. Equit ies Mark et Share

NYSE Group

47%

NASDAQ

31%

ATSs

4%

Broker

Internalization

13%

Regional

Exchanges

2%

ECNs

3%


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Alternative Execution Venues SEPTEMBER 2006

2006 Aite Group, LLC. All rights reserved. Reproduction of this report by any means is strictly probihited. Page 2 of 29

This Impact Note examines the key alternative execution venues in the U.S.

equities market and will analyze their future prospects over the next few years.

M A R K E T S T R U C T U R E E V O L U T I O N

The U.S. equities market structure has undergone major changes over the last

decade. In the aftermath of the Order Handling Rules (OHR) of 1997, competition

increased substantially and lead to the creation of various independent execution

venues including ECNs and private ATSs. Market fragmentation appeared to be the

norm, at least in NASDAQ, as various viable execution venues emerged to

seriously threaten NASDAQ for execution revenues.

However, by 2002, a wave of consolidation began that was triggered by the merger

between Archipelago and REDIBook (owned, at that time, by Goldman Sachs). The

most significant ECN merger occurred when Instinet acquired Island (forming

INET), its chief competitor in the ECN market. NASDAQ went on a spending spree

soon after that and was determined to recapture its lost market share by acquiring

FIGURE 2: TIMELINEOF U.S. EQUITIES EXECUTION VENUES

Source: ECNs, Aite Group

Order HandlingRules (OHR)approved. Launch ofIsland, Archipelago,and REDIBook

Instinet/Islandmerger

1997

Launch ofNASDAQSuperMontage

Launch of Instinet

1969 2005 20061998

Feb 1998: Launch of AttainNov 1998: Launch of NexTradeand Strike TechnologiesLate 1998: Launch ofBloomberg TradeBook

1999 20032001 20022000 2004

BRUT/Strike mergerArchipelago and PacificStock Exchange to launchelectronic stock exchange

NYSE launchesDirect+

Launch of TrackECNArchipelago/REDIBook

merger

Launch of BATSECN

Knight acquiresAttain andrenames it DirectEdge ECN

Citigroup acquires

OnTrade ECNfrom NexTrade

1987: Launch ofITG POSIT

Launch of Liquidnet

Launch of Pipeline

NASDAQacquisition ofBRUT

NYSE acquisition ofArcaEx and NASDAQacquisition of INET

Order HandlingRules (OHR)approved. Launch ofIsland, Archipelago,and REDIBook

Instinet/Islandmerger

1997

Launch ofNASDAQSuperMontage

Launch of Instinet

1969 2005 20061998

Feb 1998: Launch of AttainNov 1998: Launch of NexTradeand Strike TechnologiesLate 1998: Launch ofBloomberg TradeBook

1999 20032001 20022000 2004

BRUT/Strike mergerArchipelago and PacificStock Exchange to launchelectronic stock exchange

NYSE launchesDirect+

Launch of TrackECNArchipelago/REDIBook

merger

Launch of BATSECN

Knight acquiresAttain andrenames it DirectEdge ECN

Citigroup acquires

OnTrade ECNfrom NexTrade

1987: Launch ofITG POSIT

Launch of Liquidnet

Launch of Pipeline

NASDAQacquisition ofBRUT

NYSE acquisition ofArcaEx and NASDAQacquisition of INET


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BRUT. This consolidation trend hit its peak when the NYSE acquired ArcaEx and

when NASDAQ teamed up with INET, thereby creating a de facto duopoly in the

U.S. equities market. The conception and passage of Regulation NMS has also

played a key role in recent market developments as new and incumbent execution

venues look for opportunities in the post-Reg NMS market structure.

The end result of all these M&A activities was that in a short span of time, all of the

large ECNs had disappeared and had left the ECN market littered with smaller

players. Perhaps more importantly, the NYSE and NASDAQ forcefully moved back

to the top of the execution market (see Figure 3 on page 3).

Going against this industry trend of consolidation has been the acceleration of

market fragmentation, at least on the surface. Since 2002, a number of ATSs, led

by Liquidnet, have emerged to meet the growing need for block trading in the

marketplace. Fearful of total dominance by the NYSE and NASDAQ, large dealers

and a number of buy-side firms have formed partnerships to either support

existing regional exchanges or to create new execution venues. Large bulge

FIGURE 3: MARK ET CONSOLIDATION

Source: ECNs, NASDAQ, NYSE Group, Aite Group

1997

Instinet

Order Handling Rulesof 1997 Implemented

Acquired by Knight and renamed Direct Edge ECN

20061998 2000 2002 2004

Island

Archipelago

REDIBook

BRUT

Strike

Bloomberg TradeBook

Attain

NexTrade

Track ECN

BATS

Acquired by Citigroup

Merger with BRUTAcquired by NASDAQ

Merger with Instinet,renamed INET

Acquired byNASDAQ

Merger withArchipelago Acquired by NYSE

NYSENYSE

NASDAQNASDAQ

1997

Instinet

Order Handling Rulesof 1997 Implemented

Acquired by Knight and renamed Direct Edge ECN

20061998 2000 2002 2004

Island

Archipelago

REDIBook

BRUT

Strike

Bloomberg TradeBook

Attain

NexTrade

Track ECN

BATS

Acquired by Citigroup

Merger with BRUTAcquired by NASDAQ

Merger with Instinet,renamed INET

Acquired byNASDAQ

Merger withArchipelago Acquired by NYSE

NYSENYSE

NASDAQNASDAQ


4/29



bracket firms have also jumped into the fray by either launching or developing

internal crossing engines designed to take advantage of the massive order flow

going through their trading desks.

E L E C T R O N I C C O M M U N I C A T I O N N E T W O R K S ( E C N S )

Over the past nine very competitive years, ECNs have played a key role in

fundamentally changing the competitive landscape in the U.S. equities market,

especially in trading NASDAQ stocks. With the acquisition of all of the major ECNs

by leading exchanges, however, it is highly questionable how some of the

remaining ECNs will actually perform in the post-Reg NMS market structure.

The only ECNs with formidable liquidity are Bloomberg TradeBook (which has

expanded its focus into other asset classes, including futures and FX) and DirectEdge ECN (see Figure 4 on page 5). Despite the odds, a new ECN called the Better

Alternative Trading System (BATS) launched on January 2006. Overall, ECNs

currently account for 6% of the entire U.S. equities market (see Figure 5 on

page 5).

TABLE A: ECNS LEFT STANDING

ECN Launch Date OwnershipAverage Daily Trade

Volume

Bloomberg TradeBook Late 1998 Bloomberg 150 million

Direct Edge (formerly

At tain)*

February 1998 Knight Trading 70 million

OnTrade November 1999 Citigroup 1.5 million

BATS J anuary 2006 Tradebot Systems, etc. 7.9 million

Track ECN April 2002 Track Data Corporation 11.9 million

Source: ECNs, Aite Group estimates

*Includes both matching and routing


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FIGURE 4: ECN MARK ET SHARE ANALYSIS

Source: ECNs

FIGURE 5: ECNS MARK ET SHAREINTHE U.S. EQUITIES MARK ET

Source: ECNs, NYSE, NASDAQ, Aite Group estimates

ECN Mark et Share

OnTrade

1%

Direct Edge

29%

Bloomberg

TradeBook

62%

Track ECN

5%

BATS

3%

% of ECN Mark et Share in U.S. Equi ties Mark et Q2 2006

ECNs

6%

U.S. EquitiesMarket

96%


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BATS TRADING

Launched in January 2006 and headquartered in Kansas City, MO, BATS is the

newest entrant in the ECN market. BATS is a spin-off from Tradebot Systems, one

of the leading automated liquidity providers in the U.S. equities market. BATS'

other investors include GETCO and Wedbush. BATS currently has about 20employees.

In the second quarter of 2006, BATS was the first ECN to make the switch from

Nasdaq SuperMontage to NSX. This initially caused their volumes to drop, but this

switch positions BATS well, relative to other ECNs, when SuperMontage becomes

unavailable this fall.

BATS' volume has been steadily climbing since they completed the migration to

NSX and changed pricing on July 1, 2006. BATS volume reached a peak of 43

million shares on August 28, 2006 (see Figure 6 on page 6).

BATS currently has about 60 subscribers, a number which has been growingbetween 5 and 10 per month. While BATS is only open to the sell-side, buy-side

firms can have access to BATS via sponsorship from their brokers. BATS has been

averaging about 500 shares in executed trade size. Some of the key data on BATS

include the following:

FIGURE 6: AVERAGE DAILY TRADE VOLUME PROGRESSOF BATS

Source: BATS

BATS Aver age Daily Trade Volu m e

0

5,000,000

10,000,000

15,000,000

20,000,000

25,000,000

30,000,000

35,000,000

1/27/2006

2/10/2006

2/24/2006

3/10/2006

3/24/2006

4/7/2006

4/21/2006

5/5/2006

5/19/2006

6/2/2006

6/16/2006

6/30/2006

7/14/2006

7/28/2006

8/11/2006


7/29


8/29



Although entering a hyper competitive marketplace, BATS has managed to gain a

respectable market share in a short period of time. The liquidity provided by

Tradebot, Getco, and other quantitative liquidity providers has no doubt given

BATS an advantage among the newer market centers. BATS' competitive pricing

schedule has also played a key role in its market acceptance to date. In order to

increase its market presence, however, BATS will have to demonstrate that it canattract more liquidity removers.

D IRECT EDGE ECN

Launched in 1998 and formerly known as Attain (founded by All-Tech Investment

Group), Direct Edge ECN has been re-energized thanks to the acquisition by Knight

Capital Group in Q2 2005. Re-branded as Direct Edge ECN, it has experienced

significant volume growth in recent quarters and averages 70 million shares a day

as of August 2006 (see Figure 8 on page 8). More than half of that volume is being

matched internally within Direct Edge (see Figure 9 on page 9). This places Direct

Edge right behind Bloomberg Tradebook in terms of overall market share in the

ECN market. Headquartered in Jersey City, NJ, there are currently 15 employees

fully dedicated to Direct Edge ECN with 15 more resources available from the

Knight infrastructure group.

FIGURE 8: AVERAGE DAILY SHARE VOLUMEOF DIRECT EDGE ECN

Source: Direct Edge ECN

Dire ct Edge A ver age Daily Trade Volum e

0

10,000,000

20,000,000

30,000,000

40,000,000

50,000,000

60,000,000

70,000,000

80,000,000

90,000,000

3/1/2006

3/15/2006

3/29/2006

4/12/2006

4/26/2006

5/10/2006

5/24/2006

6/7/2006

6/21/2006

7/5/2006

7/19/2006

8/2/2006

Number of Shares


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Currently, Direct Edge displays its orders on both the Alternative Display Facility

(ADF) and SuperMontage under the market participant identifiers (MPIDs) EDGA

for ADF and EDGX for SuperMontage. However, as NASDAQ migrates over to the

INET platform, EDGX will also be migrating over to ADF. Key Direct Edge

information includes the following:

Looking to provide enhanced liquidity with high levels of fill

rate at competitive pricing;

Open to broker-dealers;

Ability to trade NASDAQ National Market and Small Cap

stocks;

Submission of orders through Direct Edge Portal which

integrates client OMS with Direct Edge ECN;

Direct Edge View enabling depth-of-book look into Direct

Edge ECN;

Three display options: fully display, reserve, and hidden; and

Competitive pricing schedule: charging US$.003 per share for

liquidity takers and offering rebate of US$.0022 per share for

liquidity providers.

FIGURE 9: BREAKDOWNOF DIRECT EDGE ECN VOLUME

Source: Direct Edge ECN

Details Behind Dir ect Edge ECN Trade V olum e

Internal Match

55%

Routed Out

45%

Aver age Daily Tr ade Vo lum e = 70 m il lion s har es


10/29



Prior to the acquisition by Knight Capital Group, Direct Edge ECN (at that time

known as Attain) was one of the smallest ECNs in the marketplace. With the

backing of Knight, however, Direct Edge has jumped into the leadership position

and is continuously growing its market share. Future projects include moving into

the listed market, introducing sophisticated order types to tap into dark pools of

liquidity, and potentially providing algorithms to better access the ECN.

B L OC K TRA DI NG NE TW OR K S

Unlike the ECNs which seem to be disappearing from the competitive landscape,

the popularity of ATSs appears to be only increasing, especially for those platforms

serving the block trading market.

ITG POSIT

Founded in 1987 as a subsidiary of Jefferies & Co. and headquartered in New York,

Investment Technology Group (ITG) is a technology-driven agency broker that was

initially made famous for POSIT (its equities private crossing network) and

QuantEX (the industry's first trading platform to support quantitative trading,

which launched in 1991). As the clear pioneer in the marketplace, ITG gained a

strong following from the buy-side quant traders during the 1990s.

ITG has nurtured an entire generation of technologists and quantitative analysts

who are leading Wall Street's push towards the adoption of advanced trading

services. ITG currently has 1,015 employees worldwide with operations in theUnited States, Canada, Europe, Australia, Hong Kong, and Japan.

ITG's strength has always been its reliance on technology to attract and manage

clients. ITG's recent flurry of acquisitions and growth followed years of uncertainty

and doubt during the early 2000s. Rumors were rampant of their imminent

acquisition by larger brokers as their market share continued to decline in both

TAB LE B: BLOCK TRADING PLATFORMS

Platform Launch Date Ownership Average Trade Size

ITG POSIT 1987 ITG 23,000

Liquidnet 2001 Privately owned with private

equity funding from TH Lee

Putnam Ventures, Summit

Partners, and Technology

Crossover Ventures.

48,000

Pipeline 2004 Pipeline 42,000

NYFIX Millennium 2001 NYFIX 600

Source: Firms, Aite Group estimates


11/29



their trading front-ends and POSIT. The emergence of new, more nimble and

lower-cost providers appeared to spell their eventual doom.

However, the re-birth of ITG occurred quite swiftly. With the introduction of Triton,

ITG aggressively moved to replace QuantEX, its popular but outdated trading

platform. ITG also went on an acquisition spree by purchasing Macgregor, a leadingbuy-side OMS provider, as well as Plexus, a leading TCA service provider. Through

internal development and acquisitions over the last couple of years, ITG has

created a suite of products and services that are capable of supporting the entire

trade life-cycle -- from pre-trade and trade to post-trade analysis.

For the purpose of this report, only POSIT will be examined. POSIT falls under

ITG's Trade & Execution Services. Launched nearly 20 years ago, POSIT is the

oldest crossing platform in the marketplace. As of Q2 2006, POSIT averaged

approximately 46 million shares a day with an average trade size of 23,000 shares

(see Figure 11 on page 12). POSIT has increased its trade volume significantly

over the last few quarters after a brief decline that began in late 2003. Currently,ITG has three flavors of POSIT:

FIGURE 10: BREAKDOWNOF ITG PRODUCTSAND SERVICES

Source: ITG

Pre-Trade

Anal ytics

Trade &

Execution

Post-Trade

Anal ysi s

ITG Logic

ITG/Opt

ITG eXtra

POSIT

Triton

Radical

Macgregor XIP

ITG Algorithms

ITG Trading

Services

TCA

Fair Value

Model

Plexus

Plexus

ITG Hoenig

Pre-Trade

Anal ytics

Trade &

Execution

Post-Trade

Anal ysi s

ITG Logic

ITG/Opt

ITG eXtra

POSIT

Triton

Radical

Macgregor XIP

ITG Algorithms

ITG Trading

Services

TCA

Fair Value

Model

Plexus

Plexus

ITG Hoenig


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POSIT Match. Launched in 1987, POSIT Match is ITG's

classic scheduled crossing service that provides anonymous,

mid-point matching with zero market impact. POSIT Match is

open to both the sell-side and the buy-side.

POSIT Now. Launched in 2001, POSIT Now is a continuous

crossing service (every 30 seconds) which currently accounts

for the fastest growth rate. POSIT Now is open to both the

sell-side and the buy-side.

Block Alert. Originally launched in Q3 2005 as POSIT Alert,

Block Alert is a Liquidnet-type crossing mechanism where

blotters of OMSs are tied together to seek active crossing

opportunities. Block Alert sits outside of the passive matching

POSIT network and invites users to participate. There is no

negotiation process in Block Alert to ensure that all order

information is anonymous. POSIT Alert was re-branded in the

first quarter of 2006 as Block Alert as part of a joint venture

with Merrill Lynch that paired Merrill Lynch's liquidity with

ITG's crossing technology. Block Alert requires users to

adhere to a minimum trade size based on the average daily

trade volume:

- Large-cap: 25,000 shares;

FIGURE 11: AVERAGE DAILY SHARE VOLUME

Source: ITG, Aite Group estimates

POSIT's Aver age Daily Share Volum e

0

5

10

15

20

25

30

35

40

45

50

Q402

Q103

Q203

Q303

Q403

Q104

Q204

Q304

Q404

Q105

Q205

Q305

Q405

Q106

Q206

Mns of Shares

0%

10%

20%

30%

40%

50%

60%

70%

80%

% of Market

Share

Average Daily Share Volume % of Market Share


13/29



- Mid-cap: 5,000 shares; and

- Small-cap: 1,000 shares.

Users can access POSIT liquidity by utilizing Channel ITG, a trading tool. Once

Channel ITG is integrated with an OMS, it can automatically sweep the OMS blotter

and send out orders to multiple ITG execution venues. Channel ITG is currently

integrated with Macgregor, Eze Castle, and Charles River. Users can also access

POSIT using ITG's two trading front-ends or a direct FIX connection:

Triton. This is ITG's flagship portfolio-trading application

which has replaced QuantEX. Triton provides full list and

order management for portfolio trading with a complete audit

trail.

Radical. This is ITG's Windows-based EMS platform for

single-stock trading. Similar to Triton, Radical is broker-

neutral and has access to all major execution venues as well

as broker algorithms.

POSIT continues to look for additional market opportunities outside of the U.S.

market. Indeed, POSIT has become a global offering with its presence in Europe,

Canada, Australia, and Japan.

L IQUIDNET

Launched in 2001 with 38 buy-side members, Liquidnet is the current market

leader in block trading platforms. Liquidnet came out of nowhere in 2001 to

compete against ITG's POSIT service and ultimately became the largest block

trading network in 2004. Liquidnet is headquartered in New York and currently has

185 employees.

Liquidnet started out as a buy-side-only network with a very simple concept -- to

enable buy-side to buy-side block trading without broker involvement. The key to

Liquidnet's initial success was its ability to link up with all of the major buy-side

OMS vendors. The Liquidnet platform essentially sweeps the trade blotters of its

members, and when there is a natural execution to be made, it alerts both parties,

and only those parties, so they can begin negotiating. Liquidnet's timing could not

have been better than at the time of its launch, as the institutional market was

struggling to find a large size in the public market without causing market impact.

Not surprisingly, Liquidnet's simple concept caught on quickly, and it enabled

Liquidnet to eventually attract an impressive US$250 million investment from

Summit Partners and Technology Crossover Ventures during Q1 2005.

Continuing to build on its success, Liquidnet had 341 members as of Q2 2006; a

majority of these members (85%) are from North America (see Figure 12 on


14/29



page 14). Liquidnet's average daily trade volume has also skyrocketed, averaging

45 million shares per day during Q2 2006 and a high of nearly 76 million shares in

July. Liquidnet's current volume accounts for approximately 36% of the block

trading network market (see Figure 13 on page 14).

FIGURE 12: LIQUIDNETS MEMBERSHIP BREAKDOWN

Source: Liquidnet

FIGURE 13: AVERAGE DAILY SHARE VOLUMEAND GROWING MARKET SHARE

Source: Liquidnet, Aite Group estimates

Liquidnet Members hip

North America

86%

Europe

14%

Total Num ber of Me m ber s = 341 (as of Q2 2006)

Liquinet's Average Daily Share Volum e

0

5

10

15

20

25

30

35

40

45

50

Q402

Q103

Q203

Q303

Q403

Q104

Q204

Q304

Q404

Q105

Q205

Q305

Q405

Q106

Q206

Mns of Shares

0%

5%

10%

15%

20%

25%

30%

35%

40%

45%

50%

% of MarketShare



15/29



The bulk of Liquidnet's business is done with the mid-cap and large-cap stocks;

combined, they account for 80% of all shares traded and over 70% in total

execution (see Figure 14 on page 15). Meanwhile, small- and micro-cap names

account for 27% of the firms executions, yet they tend to dominate the block volume in

those names. Approximately one out of every three small- and micro-cap names that

are executed in Liquidnet represent 100% of the block trading volume in that name forthe day. Liquidnet has also done quite well on the NYSE-listed stocks which account for

61% of total shares traded and 57% of total execution (see Figure 15 on page 15).

FIGURE 14: LIQUIDNET STATISTICS BASEDON MARK ET CAP

Source: Liquidnet

FIGURE 15: LIQUIDNET STATISTICS BASEDON EXCHANGE

Source: Liquidnet

Liquidnet Perfor m ance Based on Mark et Cap

32%

48%

17%

3%

21%

52%

23%

4%

0%

10%

20%

30%

40%

50%

60%

Large Cap Mid Cap Small Cap Micro Cap

% of Shares Traded % of Executions

Liquidnet Perfo rm ance Based on Exchange

61%

38%

57%

42%

0%

10%

20%

30%

40%

50%

60%

70%

NYSE NASDAQ

% of Shares Traded % of Executions


16/29



In 2002, Liquidnet launched its European initiatives from the UK. Liquidnet has

expanded its European coverage over the last couple of years and currently

includes the UK, France, Germany, Italy, the Netherlands, Switzerland, Belgium,

Denmark, Finland, Norway, Sweden, Portugal, Iceland and Luxembourg. Liquidnet

Europe Limited has quickly grown to be ranked among the largest agency brokers

on the London Stock Exchange (LSE), breaking into the top 10 this summer as theninth largest broker. Figure 16 on page 16 illustrates Liquidnets growing presence

in the European block trading market.

In recent months, Liquidnet has introduced H20, which is designed to position the

large buy-side liquidity of Liquidnet to absorb smaller retail as well as algorithmic

flow coming from various ECNs, exchanges and sell-side streaming liquidity

providers including Bloomberg TradeBook, BNY Brokerage, Instinet, FutureTrade,

Miletus Trading, Piper Jaffray, EdgeTrade, UNX, Goldman Sachs Execution &

Clearing (GSEC), Lehman Brothers and Credit Suisse.

Not content with its initial success in the U.S. equities market, Liquidnet continues

to seek global opportunities. During Q2 2006, Liquidnet opened its Hong Kong and

Tokyo offices with expectations of opening up another office in Australia before the

end of 2006. The goal is to launch its services in the Asian market during the first

half of 2007. Liquidnet also received approval from the Ontario Securities

Commission (OSC) to trade Canadian equities starting in Q4 2006.

FIGURE 16: LIQUIDNETIN EUROPE

Source: Liquidnet

Total Prin cipal Traded

4841,102

1,4921,955

3,158

5,023

8,262

-

1,000

2,000

3,000

4,000

5,000

6,000

7,000

8,000

9,000

H1 2003 H2 2003 H1 2004 H2 2004 H1 2005 2H 2005 1H 2006

Mns of GBP


17/29


18/29



NYFIX Millennium, which is a sell-side-only network (providing buy-side access via

sell-side brokers or directly via NYFIX Transaction Services), attracts various types

of orders, including retail flow (over 150 streaming retail providers), institutional

trading desks, directed buy-side flow, conditional orders from agency desks, and

hedge fund flow. NYFIX Millennium is a real-time, anonymous, continuously

matching platform with the potential for price improvement. NYFIX Millennium istechnically not a block trading network, as its average trade size is only 600 shares

(which is still larger than the average trade size in the public market). In order to

bring in a maximum level of liquidity, NYFIX has maintained a broker-neutral,

vendor-neutral, and network-neutral policy. NYFIX has integrated Millennium into

about 40 OMSs.

In late 2005, building on its success of Millennium, NYFIX launched Millennium

Natural, its buy-side-only service (including large hedge funds) that targets block

trading. There are currently 75 buy-side firms involved in Millennium Natural.

There are minimum order size requirements of 25,000 shares for Dow component

stocks, 10,000 shares for S&P component stocks, and 5,000 shares for non-S&Pcomponent stocks to generate a NYFIX Natural IOI to stimulate block order

interactions amongst the buy-side clients.

FIGURE 17: NYFIXS AVERAGE DAILY SHARE VOLUMEAND MARKET SHARE

Source: NYFIX, Aite Group estimates

NYFIX's Aver age Daily Share Volum e

0

5

10

15

20

25

Q402

Q103

Q203

Q303

Q403

Q104

Q204

Q304

Q404

Q105

Q205

Q305

Q405

Q106

Q206

Mns of Shares

0%

2%

4%

6%

8%

10%

12%

14%

16%

18%

20%

% of Market

Share



19/29



P IPELINE TRADING SYSTEMS

Launched in September 2004, Pipeline Trading Systems is the newest entrant in

the block trading game. However, the origin of Pipeline goes all the way back to

1999, and its management team has a wealth of experience in dealing with

electronic markets. For example, Pipeline (as a subsidiary of e-XchangeAdvantage) was involved in developing the Liquidity Tracker (designed to facilitate

block trading among dealers) which functioned briefly within NASADQ in 2002.

Pipeline also built BlockLink for Instinet, a block trading platform, which never

launched due to Instinets merger with Island. Pipeline is headquartered in New

York and currently has over 50 employees.

The third time has indeed been a charm for the management of Pipeline as despite

existing stiff competition from Liquidnet and POSIT, Pipeline has quickly gained a

large following in the marketplace. Pipeline currently averages over 17.2 million

shares a day and represents over 13% in total market share (as of Q2 2006). As

an isolated number, Pipelines growth over the last few quarters has been

impressive. What is more telling is that when one compares these numbers to

industry leader Liquidnets numbers, Pipeline was able to reach the 10 million

shares-per-day milestone in only six quarters, whereas Liquidnet took 10 quarters

to achieve a similar feat.

FIGURE 18: PIPELINES AVERAGE DAILY SHARE VOLUMEAND MARK ET SHARE

Source: Pipeline, Aite Group estimates

Pipeline's Aver age Daily Share Volum e

0

2

4

6

8

10

12

14

16

18

20

Q304 Q404 Q105 Q205 Q305 Q405 Q106 Q206

Mns of Shares

0%

2%

4%

6%

8%

10%

12%

14%

16%

% of Market

Share



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Pipeline supports a completely open community with both buy-side and sell-side

participation. Pipeline currently has 367 participants with a good mixture of both

buy-side and sell-side firms (see Figure 19 on page 20).

Pipelines Block Board is a simple thin-client application that provides a real-time

view into Pipelines liquidity. The key to Pipelines success is the way the system is

designed to discourage gaming behavior. Some of the key features of Pipeline

include the following:

FIGURE 19: PIPELINE COMMUNITY BREAKDOWN

Source: Pipeline

FIGURE 20: SCREENSHOTOF PIPELINES BLOCK BOARD

Source: Pipeline

Pipeline Community Breakdown

Buy-side68%

Sell-side

32%

Total Num ber of Firm s = 367


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FIGURE 21: AVERAGE DAILY TRADE VOLUME

Source: Firms

FIGURE 22: BLOCK TRADING ATS MARK ET SHARE Q1 2006

Source: ITG, Liquidnet, NYFIX, Pipeline, Aite Group estimates

Aver age Daily Tr ade Vo lum e

0

20

40

60

80

100

120

140

Q402 Q103 Q203 Q303 Q403 Q104 Q204 Q304 Q404 Q105 Q205 Q305 Q405 Q106 Q206

Mns of Shares

Liquidnet POSIT Pipeline NYFIX Millennium TOTAL

Block Tr ading ATS Mark et Share Q2 2006

Liquidnet

36%

POSIT

35%

Pipeline

13%

NYFIX Millennium

16%


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In total, the average daily trade volume from block trading platforms has increased

from 35 million shares per day in 2002 to 130 million shares per day at the end of

Q2 2006. Despite their tremendous growth, block trading platforms account for

only 3% of the entire U.S. equities market (see Figure 23 on page 23). As

evidenced by their enormous growth over the last three years, the lack of

penetration in the market also means that these block trading platforms holdtremendous growth potential, especially as the primary U.S. equities execution

venues continue to face dwindling trade size and the threat of information leakage.

FIGURE 23: REALITY CHECKFOR BLOCK TRADING PLATFORMS

Source: NASDAQ, NYSE, Liquidnet, ITG, Pipeline, NYFIX, Aite Group estimates

Reality Check on Block Trading Platfor m Grow th

41.0 51.7 84.8 130.4

3,083.93,258.0

3,467.7

4,093.0

1%2%

2%

3%

0

500

1000

1500

2000

2500

3000

3500

4000

4500

2003 2004 2005 Q206

Mns of Shares

0%

1%

1%

2%

2%

3%

3%

4%

% of Overall

Market

Block Trading ATS U.S. Equities Market % of Overall Market


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S I N G L E - B R O K E R C R O S S I N G F A C I L I T I E S

In recent months, even individual brokers have joined the execution venue

competition by launching internal crossing platforms designed to provide

anonymous crossing for their client base. Depending on the firm, crossing could

involve order flow from institutional clients, retail clients, algorithmic clients, aswell as proprietary trading desks. Table C on page 24 provides a sample list of

brokers and their internal crossing platforms.

The concept of internalization is nothing new to these large brokers that have

enough liquidity to provide anonymous crossing services prior to sending the client

order flow to public markets and other execution venues. In fact, brokerinternalization currently accounts for 12% of all executions in the U.S. equities

market (see Figure 24 on page 25). The difference now is that instead of manually

providing internalization or internal crossing, firms are developing platforms to

automate and centralize the process.

From the brokers perspective, internal crossing provides cost savings in terms of

eliminating exchange transaction fees. From the clients perspective, internal

crossing can provide rapid, anonymous executions with minimum market impact.

In order to succeed in driving adoption, however, brokers must be able to beat or

at least meet the NBBO to provide greater chances of price improvement and to

minimize the market impact. Without consistently meeting these two important

requirements, further adoption of these dark pools of liquidity will be tough to

achieve.

TABLE C: SINGLE-BROKER INTERNAL CROSSING PLATFORMS

Broker Launch Date Internal Crossing Platform

Banc of America Securities 2004 Premier Block Trading

Citigroup 2005 Advanced Crossing Engine

CSFB 2004 CrossFinder

Goldman Sachs 2005 SIGMA X

Instinet 1998 Intraday & End-of-day Crossing, CBX Institutional

ECN

Knight Capital Group 2006 Knight Match

Morgan Stanley 2005 MS Pool

UBS 2005 PIN

Source: Firms, Aite Group estimates


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P R O J E C T E D P O S I T I O N S

ECNS

With the disappearance of INET as a result of its acquisition by NASDAQ, it has

now become official: ECNs are dead as an innovative business model. Their market

relevance no longer exists in the NASDAQ market. In fact, in order for the smaller

ECNs to survive, they will have to look for a buyer. Attain took the first plunge in

this regard by being acquired by Knight Securities, followed by NexTrade with

Citigroup. BATS, one of the newest entrants, has brought some life back into the

overall ECN market. However, with all of the major ECNs disappearing due to M&A

activities, ECNs, as an industry, will have a minimum impact on the overall

evolution of the equities market.

ATS

Those ATSs in the block trading business should benefit even more from Reg NMS.

Extending the Order Protection Rule to block trading has, in essence, made the

institutional trading environment even more hostile toward large block orders.

Private block trading platforms, such as Liquidnet, ITG, and Pipeline, will continue

to be viable execution destinations for those buy-side firms looking for anonymity,

speed, and liquidity. These ATSs will remain niche players but will continue to build

market share over the next few years. Competition is getting tougher, however. It

has been driven by exchanges launching crossing services as well as large sell-side

firms building internal crossing engines in the hope of recapturing some of the

order flow they have lost to these block trading facilities.

SEL L -SIDE

Not surprisingly, large sell-side firms have been quite active in seeking

opportunities in this ever-changing competitive landscape:

Investments in existing exchanges. Bulge bracket firms

have poured millions of dollars into various regional

exchanges in recent months. Whether or not order flow will

follow these investments is not clear at this point.

Purchase of ECNs. Some of the large brokers have opted tobuy existing ECNs, such as Knight Securities and Citigroup.

This could certainly help these brokers to secure transaction

revenue, but it could also improve brokers potential to

capture additional revenue through market data distribution.


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R E L A T E D A I T E G R O U P R E P O R T S

U.S. Equities Market in Transition: Evaluating Leading Exchanges, September

2006.

U.S. Equities Market in Transition: Looking for Liquidity in All the Wrong Places?

August 2006.

IT Spending in U.S. Securities & Investments in 2006: The March Towards

Automation and Regulatory Compliance, April 2006.

Soft Dollars & Bundling: Here to Fight Another Day, April 2006.

Compliance in 2006: Blazing Flashes in an Obvious Market, February 2006.

Top 10 Securities & Investments Trends in 2006, December 2005.

Shaking Up Prime Brokerage: Unbundling Securities Lending, Financing, and

Derivatives Transactions, October 2005.

Future of Electronic Connectivity: In the Aftermath of Regulation NMS, July 2005.

Regulation NMS: Will the Real Winner Please Stand Up?April 2005.

Algorithmic Trading: Hype or Reality?, March 2005.

IT Spending in U.S. Securities & Investments in 2005: A New Beginning, January2005.

aite-alt execution sep2006

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