The Algo That Entices Fund Managers to Beat New EU Trading Caps

  • Liquidnet’s new product comes months before European overhaul
  • MiFID II limits how much trading can take place in dark pools

The financial industry is preparing for change and making changes ahead of Europe's new MiFID II rules. Bloomberg's Jason Kelly examines the response of the financial industry on 'Bloomberg Surveillance.' (Source: Bloomberg)

Liquidnet Holdings Inc. has devised an algorithm to entice the world’s largest fund managers to place big stock trades with each other, an innovation designed to avoid upcoming curbs on dark pools in Europe.

The dark pool’s 300 or so European asset manager clients will be able to select its Targeted Invitations algorithm when they place their orders. The software will examine the past 60 days of trading for that stock, identifying three or four investors who might want to take the other side of the trade, even though they haven’t yet entered an order.

The European Union’s MiFID II overhaul exempts large orders from limits on how much stock trading can take place in dark pools. As many fund managers rely on these private markets to avoid tipping off rivals about their intentions, an algorithm that encourages other investors to trade with them becomes more valuable.

“On average the targeted invitation will go to about three recipients,” Chris Jackson, Liquidnet’s head of execution and quantitative services, said in an interview. “It does not go to 50, it does not go to 100. If you have been a buyer and a seller of a stock on the same day, you would not receive an invitation. If you have put an active order in today, you will be top of the queue. Most invitations are sent when there has been an active order in the last week or so.”

MiFID II forces dark pools to stop trading stocks when the volume of that stock traded in the dark reaches an 8 percent threshold based on the previous 12 months of activity. A separate cap limits trading of a stock on a single dark pool to 4 percent of overall trading volumes. Any trading halt will last for six months. The new rules take effect in January.

Read more: how European equity trading can stay in the dark under MiFID II

Liquidnet has offered Targeted Invitations as a manual process for the last year, but not as an algorithm. While the algorithm can tell who owns a stock and has recently placed an order to trade it, the fund managers will never know who they traded with.

“On average the execution size that we get for a Targeted Invitation is $1.9 million a print,” Jackson said. “In comparison, the average dark pool cross outside Liquidnet is $20,000.”

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