Support The Market Structure You Want

April 11, 2015

Dear Aqua friends and prospects:

Greetings from the Aquarium!

If there’s one lesson for the buyside to draw from the current HFT debate undoubtedly it is this:
support the market structure you want. Don’t just ask about trade volumes. If you make trade
volume the first requirement of your liquidity pools, you shouldn’t be surprised when you end
up with the market structure somebody else wants. To get the market structure you want, you
have to make it a priority and support it with your business.

At AQUA we have stayed true to our mission. We facilitate block trades with price discovery and
no leakage. We haven’t juiced our volumes and we don’t cater to HFT. To protect our clients
from HFT pinging, we won’t even take an order smaller than 2500 shares. More about that later.


With the focus these past several weeks on everything that’s wrong with our market, it’s worth
recalling the ways in which the old system wasn’t so great either. When institutional trading
grew to be too large for the old model, the buyside did something about it ‐‐ they voted with
their order flow for alternatives that dramatically improved their execution quality – for awhile,

Back when NYSE and Nasdaq faced no competition, the buyside complained bitterly that their
pre‐trade order information wasn’t being protected. No doubt there were people in both the
NYSE and Nasdaq markets who worked hard for their clients. But the overriding currency of the
day ‐‐ both upstairs and down on the floor ‐‐ was information about large pending buyside
orders. Institutional investors were looking for an alternative. In Washington there was worry
the U.S. equities markets could be beaten in our own backyard by Deutscheborse’s Xetra or by
Euronext if we failed to modernize.


The solution was uniquely American: investors’ interests would be served by competition.


When I created Bloomberg Tradebook our guys went out with an alternative made possible by
the new order handling rules: the buyside could find new liquidity for their Nasdaq orders in the
explosion of small orders coming from internet brokers, day traders, options market‐makers and
program traders. The large order market and small order market previously referenced each
other for prices, but they didn’t trade with each other. That changed when Tradebook and the
other ECNs voluntarily linked to each other with private FIX connections. Tradebook clients
would just peg their big orders to the market, using our new reserve and discretion tools and
breaking everything into smaller slices, and ‐‐ whoosh! ‐‐ an entirely new source of liquidity.


We built a hugely profitable business this way and for several years we couldn’t believe every
broker on the Street wasn’t doing what we were doing.


Late 1999 saw the end of NYSE Rule 390, which had precluded NYSE members from trading
most NYSE stocks off‐exchange, erasing the bright line that formerly divided NYSE stocks from
Nasdaq stocks. Decimalization brought finer increments and the potential for greater
efficiencies. Around this time I got a call from our friends at CSFB with a new idea. Using our
Bloomberg front end and other platforms, they introduced an algo product that looked like
calculus to our algebra, and from that point everything changed.


When algorithmic trading first appeared, what we now know as high‐frequency trading hadn’t
yet reached the equities markets. The buyside could trade large orders with less impact using
algos, and they did. Volumes rose and with volumes came higher costs. Many algo brokers took
advantage of Reg ATS to introduce home‐grown dark pools as a way to cross flow and control
their exchange costs. Brokers battled for market share by passing the savings on to clients in the
form of lower commissions, which no one can deny fell precipitously during those years.


Reg NMS was a huge pain for everybody. But the argument that it was Reg NMS that ushered in
high‐frequency trading makes no sense to me. Reg NMS was about the trade‐through rule.
Listed stocks had one, Nasdaq didn’t. Many observers felt NYSE used trade‐through to protect
its slow‐moving monopoly. When Arca published figures showing that it was NYSE itself who
was the rule’s biggest violator, something had to change: either the rule had to be enforced, or
it had to go. The SEC’s solution was Reg NMS, which extended trade‐through to Nasdaq as well
as listed stocks. And for the first time, it would actually be enforced.


During this period HFT was developing in electronic markets in Chicago ‐‐ initially in futures,
then migrating to Treasuries and FX, and only after that in equities. High‐frequency trading has
ever since presented a new kind of challenge to the same problem of protecting pre‐trade
information from a new kind of leakage. It’s an arms race between HFT programs that infer what
will happen next and get there first, and algo programs that try not to be so predictable. And it’s
become really hard not to be predictable.


We keep our recommendations simple: try the block trade first, and put larger minimum fills on
your algo orders. These practices put more of your order outside the reach of the HFT geniuses.
Increasingly we see institutional traders willing to respond to trade opportunities with a single
click of the mouse. These are quantities that are perhaps not big enough to pick up the
telephone, but too large to interact with high‐frequency activity.

I’ll say it again: we’ve stayed true to the mission at AQUA. We facilitate block liquidity and use
price discovery to bring out merchandise. We don’t do HFT. We don’t provide direct feeds. Our
2500 share minimum sets a prohibitive cost for HFT pinging. At AQUA we don’t sales trade and
we don’t advertise trades. We don’t call to ask “are you still there?” We let our AQUA sales reps
know if their clients have traded but they don’t even see the ticker symbols. They can’t put
together trades because they don’t have enough information. We do everything we can to
protect our clients’ information. We let what happens happen. In short, the AQUA model
presents buyside traders with opportunities to trade blocks with price discovery and absolutely
no pre‐trade information leakage.

If you aren’t doing so yet, we think you would be well‐served to vote with your orders for
AQUA’s market structure.


Thanks and regards,

Kevin Foley
President and Chief Executive