Nasdaq Takes Dip in Dark Pool

Terry Flanagan

Nasdaq OMX Group’s planned launch of a dark pool for electronic U.S. Treasuries is big news for fixed income institutional investors, particularly with a possible Fed tapering coming up in early 2014, as it will provide them with a way to execute trades faster, generate higher liquidity and reduce costs in comparison to the traditional “voice brokers” method of trade execution.

The proposed dark pool, which Nasdaq chief executive Robert Greifeld announced at an industry conference, is part of a shift to electronic trading in fixed income markets.

Michael Chuang, CEO of iTB and a former UBS and Lehman Brothers bond trader, noted the implications of Nasdaq’s move for fixed income traders and the types of data and analytics fixed income traders will need to thrive in the new market place.

“On Treasuries side, trading has been fully electronic for well over a decade, so it’s pretty much status quo for anyone trading Treasuries to trade electronically at this point,” Chuang said. “However, other parts of fixed income, such as corporate bonds, are only trading about 15% – 20% electronically. I would say that a dark pool in Treasuries will be somewhat of an analogous to a dark pool in FX trading, primarily in the sense that you don’t see many of them in either market. So the launch of this dark pool would certainly position Nasdaq an innovator in this space.”

The dark pool will operate on eSpeed, am executable central limit order book for electronic trading of U.S. Treasury Securities that Nasdaq acquired this year in order to create a strategic entry point into the electronic fixed income business – one of the largest and most liquid cash markets in the world.

“We view the eSpeed platform as a compelling extension of NASDAQ OMX’s strategic direction,” said Greifeld at the time of the acquisition. “eSpeed is a major player in the U.S. Treasury market, has derivative-industry margins, and is a long-standing presence on trading desks around the world. The acquisition furthers our stated diversification strategy, and strengthens our commitment to deliver significant value to shareholders.”

In the equities markets, regulators and exchanges have often frowned upon dark pools while buy-side traders have found it to be a great resource to trade larger size without information slippage/leakage, said Chuang. However for fixed income it’s a lot different.

“There is a very broad retail presence in equities and trade sizes are very small, only a few hundred shares at a time,” he said. “Fixed income institutional investors are interested in executing much larger, block trades.”

“The minimum trade size in Treasuries (notional) is one million on all the whole sale e-trading platforms,” Chuang noted. “With that in mind, the market impact of a $50 million Treasury trade would go almost unnoticed in the fixed income market, whereas that size trade in equities would have a major impact on prices for that particular stock.”

Positive market trends (such as increasing new-issuance of U.S. Treasury securities, the continued electronification of the U.S. Treasury market and the resolution of fiscal uncertainty) will drive volume growth. In addition, as the Fed’s quantitative easing program concludes, Nasdaq expects the normalization of rates, the rate curve and volatility, all of which will feed substantially larger U.S. Treasury securities trading volume.

Chuang added: “Given that the Volker rule enables banks to continue proprietary trading for Treasuries and maintain the status quo, I don’t expect market structure to change much for Treasuries in the short term. However, a successful dark pool offering for corporate bonds can be much more impactful today in my opinion.”

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