Dark Matters: Liquidnet Unfazed by Dark-Pool Regulations

Liquidnet CIO Neal Goldstein (left) and CEO Seth Merrin

Anthony Malakian catches up with Liquidnet's two principals – Seth Merrin and Neal Goldstein – and quizzes them on their expectations relating to the SEC’s dark pool regulatory stance, and the firm's recent partnership with SIX Swiss Exchange.

Technologists, especially those on Wall Street, are not known for their free-spirited ways—except at Liquidnet. CEO Seth Merrin keeps the group loose even in the face of changing regulations, while CIO Neal Goldstein expands the firm’s IT.

Within five minutes of arriving at Liquidnet’s Midtown Manhattan offices, I was offered a beer. Suffice it to say: The culture here is like none other on Wall Street.

The broker and crossing network provider is, as CEO Seth Merrin puts it, “an intersection between Wall Street and Silicon Valley—with a heavier emphasis on Silicon Valley.”

On Fridays, an expansive buffet is laid out for the employees to enjoy. There’s a Slurpee machine and ice cream maker available daily. There’s a full snack bar and a refrigerator packed with liquid hops and barley. And in true internet start-up fashion, there’s a pool table for blowing off steam. Everybody is decked out in their best lounging-around outfits. It’s a college kid’s dream workplace environment.

“The culture here is different than anyplace else that you’ve ever seen,” says Liquidnet CIO Neal Goldstein.

And this is not just evident in the office—this is indeed the most fun-loving IT team on the Street. In December, at Waters’ American Financial Technology Awards (AFTAs), Liquidnet’s table was the liveliest. When the firm won the award for Best Data Management Initiative, the trophy was accepted by a Liquidnet employee wearing a knit cap outfitted with teddy bear ears. As the group walked off stage, the firm’s head of operations for IT, Savannah Conheady, gave an exaggerated curtsey to the crowd.

And during the photo shoot for this story, Liquidnet employees were not shy about walking into the room and laying down some old-fashioned ribbing on Merrin and Goldstein.

There is a genuine feeling of camaraderie, which has been needed lately: Liquidnet’s former CIO, Kevin Lupowitz, left to join FXall barely a month after accepting his AFTA; the review of  the Markets in Financial Instruments Directive (Mifid II) threatens to impose harsh restraints on dark pools, which have also gotten the attention of the US Securities and Exchange Commission (SEC); and there are questions as to whether liquidity in the un-lit market is set to dry up.

Even in the face of a storm, Liquidnet has kept plugging away. This month, the company expects its partnership with SIX Swiss Exchange to go live, with more such pairings still to come. Liquidnet is also kicking off an upgrade of its global network, cutting the latency on its streaming liquidity gateways and expanding its data management program. Soon it will begin looking at new datacenters. Additionally, over the past six months, the firm has been racking up numerous awards. Yes, this is a fun-loving crowd, but don’t let that distract you from the fact that this is a firm poised to expand. In fact, if Liquidnet has its way, the entire globe will be shrouded in darkness.

SIX Swiss Mix
By the end of the second quarter this year—and possibly by the time you read this—the connection between Liquidnet and the Swiss Exchange will have gone live. Under the agreement, Liquidnet’s liquidity pool will be available to exchange members and Liquidnet clients will be able to tap into the Swiss Exchange’s liquidity pool.

In order to accommodate this partnership, Liquidnet had to build a proprietary layer of its acknowledgement engine to meet the Swiss Exchange’s service levels. It also had to adjust its processes to acknowledge flow coming into the system, which Liquidnet hadn’t needed to do in Europe prior to the partnership. Liquidnet also had to build a proprietary network that was private and specific to SIX Swiss Exchange, which was accomplished in “a couple weeks,” according to Goldstein.

It’s a sea change for the firm, adds Goldstein, and it represents growth in Liquidnet’s organizational maturity. This deal is different than partnering with some flow or member, he says. In order to make this partnership work, Liquidnet was more concerned with the business processes and becoming an extension of a non-US exchange rather than acting solely as a technology provider. 

As of press time, the two companies were in a 24-hour state of promoting, testing, coding, promoting, testing and coding. Merrin and Goldstein don’t lack in confidence and fully believe the firm will rise to the challenge. They’re so confident, in fact, that Merrin says there will be more partnerships to come later this year.

Merrin declines to say which firms he is talking to, but reading the tea leaves, when he was later asked about regions that were ripe for growth for the firm, he said that Liquidnet has its sights set on under-developed and emerging markets. In addition to expanding its already significant Asia presence—it has most recently been touting its record growth in Indonesia—it will look to Eastern Europe and Latin America, where Liquidnet does not yet have a presence. “Latin America is a big focus for us right now,” Goldstein says, adding that the firm is looking to expand into other areas, such as by growing its footprint in the equity capital markets space.

Global? You Don’t Say!
In mid-March, Merrin delivered the keynote address at the World Exchange Congress in Madrid. Prior to giving his speech, he asked a colleague what they thought the topic of conversation would be at the conference. “My colleague’s response was that it would probably center on why the CEO of Liquidnet was giving the keynote at a global exchange conference,” Merrin says.

Liquidnet intends to prove, alongside its new Swiss partner, that the firm can act as a complementary agent to other exchanges. Merrin acknowledges that his peers have been hesitant to listen, but that ears have been perked in recent months.

Helping the conversation is the recent spate of exchange merger talks. The London Stock Exchange–TMX Group deal sparked what has turned into a wave as NYSE Euronext and Deutsche Börse announced plans to merge, followed by a rival offer for NYSE Euronext by Nasdaq OMX and the Intercontinental Exchange. Single-country exchanges now have a decision to make: Merge or partner, or struggle against the might of global behemoths and major pan-regional players.

Merrin adds that the exchange-consolidation story is centered on diversification of revenue and, more specifically, around diversification away from equities. Even over the last five years, he says, the institutional sector has become a progressively smaller part of exchanges’ revenue plans.

“The exchanges themselves, pre-consolidation, had not really focused on the massive growth that the institutions have had and serving their needs—they’ve tried, but they have not been successful,” he says. “I’m afraid that with the further diversification away from cash equities, their business is going to become less and less relevant to the overall exchanges.”

This is where Liquidnet’s business proposition comes into play, he adds. The firm provides a venue for institutional investors. In addition to its $12 trillion of aggregated liquidity, its average execution size in the US is about 50,000 shares, and is even larger in Europe.

“The internet has changed industries all over the world—but not this industry,” he says. “It is still so cumbersome for a US investor to invest money overseas and in different markets. I don’t think that anybody would say the best returns are always in the investor’s own backyard. We’re making the world a smaller place through technology.”

The Regulatory Front
In the face of the consolidation phase, the regulatory gambit begins to take on even greater emphasis. Of the potential market overhauls, it is Mifid II that poses the greatest threat to Liquidnet.

The firm’s three biggest complaints are: first, the requirement for pre-trade display of actionable indications of interest (IoIs); second, requiring public display of stub orders for parts of block orders; and third, requiring a minimum order size for price waiver.

In the US, the Dodd–Frank Act was perhaps surprisingly quiet on equity dark pools. But even though Congress hasn’t addressed the business practice, the SEC has taken aim.

SEC chair Mary Schapiro said in February that “the continuing growth of trading in dark pools and other types of dark venues threatens to undermine the market’s price-discovery function. Some participants may have information advantages.” In an April interview with our sibling publication Risk magazine, Schapiro said, “Hopefully, we’ll be able to turn our attention to [high-frequency trading and dark pools] over the coming months.”

Still, Merrin is confident that the SEC is a supporter of Liquidnet, and that the company will actually face less regulation than before after all is said and done.

While he has clearly got a dog in this fight, Merrin believes the SEC will go after other dark pools that have multiple flows coming in—algo flow, prop flow, retail, institutional, and so on—and which put a computer in the middle of the trading floor to match anything it can match. Those types of alternative trading systems (ATSs) are created to save on transaction costs and do not provide price improvements from what is found on the exchanges.

Merrin says the SEC will probably approve of a couple of dark pools operating in the markets, but 40 of them, and it starts to become a problem. While it’s understandable that they want to save costs, it’s ultimately viewed as not beneficial for the market, and therefore some of that flow will have to move onto the lit market for everyone’s benefit.

“The regulators in the US now understand that institutions and retail investors need very different tools,” he says. “For instance, retail needs transparency; they need the lit markets, the bids and offers. But the institutions will never put their supply and demand on the lit market; they’re not going to advertise that they want to buy a million shares for everyone to see. What we provide are tools that enable the institution to trade without that market impact, and ultimately that benefits the moms-and-pops. The SEC has recognized—and, in fact, Schapiro said it—that not all dark pools are created equal. The SEC is now saying that Liquidnet is different and it looks like there will ultimately be less regulation on Liquidnet than there was before—that’s not true of other dark pools, which are basically internalization engines.”

The Upgrades
One of the toughest challenges a CIO has to face in this turbulent regulatory market is figuring out how to be proactive without getting too far ahead of the curve. Goldstein says Liquidnet is always trying to stay one step ahead of its own proprietary solutions, while continuing to work with vendors that can partner with Liquidnet as it enters new markets or changes business plans.

“In other companies, to go into a new business you need to get the elephant, or big tech bureaucracy, to dance,” Goldstein says. “Here, it isn’t that difficult as we have built our infrastructure in a way that allows us to be more nimble.”

Ultimately, it comes down to deciding where the solution should sit: Is cost the most important thing to factor into a project, or is it quality, or time to market? For nascent projects, where success is more difficult to quantify, it’s cost. For something like enterprise-wide data management, it’s quality. Where contracts are in place, it’s impossible to ignore time to market.

Of the largest projects, outside of its partnership with SIX Swiss Exchange, Liquidnet is also upgrading both its US network and has just begun a global network upgrade in order to reduce latency from Asia, says Goldstein. He also says that the firm is starting to split off some of its niche specialities to create “as a service” offerings for reference data, tick data, and it has other ideas for its data warehousing space.

Liquidnet is also looking at enhancing its streaming liquidity gateway to cut order-acknowledgement latency to hundreds of microseconds, Goldstein says.

On the data management front, Goldstein says that now that the infrastructure is in place, the company is looking at ways to expose that data in real-world environments. For example, Liquidnet has begun to give its sales and relationship managers “actionable data,” both historical and real-time, that will alert the individual to contact a client if there is a problem or if a deadline is approaching. “I don’t think that there will ever be a time when there isn’t some sort of enterprise-wide data program being built in this company; there are always areas where we can improve,” Goldstein says. “Frankly, that’s more exciting to me than better servers or better networks for what we do in terms of providing the most bang for the buck.”


A Nail-Biter: Liquidnet was founded in 2000 and began operations in 2001 with about 50 staffers. Initially, Merrin figured the company would need 100 buy-side firms signed and live to create a “critical mass” in order to stay in business. As its launch date got closer, he lowered that estimate to 75. On launch day, that number had fallen to 38—but, obviously, it proved to be enough. Today Liquidnet has about 650 firms on its system with a staff of about 350.

First OMS: Merrin Financial, Merrin’s first start-up, launched the industry’s first non-proprietary order management system (OMS) back in 1995.

A Canadian Import: Prior to joining Liquidnet in 2008, Goldstein had been with Canadian giant CIBC. From 2006 until 2008 he headed up the bank’s technology for CIBC World Markets USA. He admits he didnt’ know much about Liquidnet in the beginning, but after about 20 interviews, he says, he was hooked on the firm’s culture.

Greatest Challenge in the Market: “Alpha,” says Merrin. He believes the equity markets have been devalued, and the Flash Crash did not help matters. Long-only managers have underperformed indices, which has led to a saturation in the indices market. Liquidnet’s job, he adds, is to help its partners to not only reduce transaction costs, but to help them find new alpha opportunities; and those opportunities are going to come outside the developed-market world.

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