When Lehman Brothers Holdings collapsed in September 2008, the London Stock Exchange lost more than its biggest provider of orders — it also lost its sole equity partner in Baikal, a new pan-European dark pool trading facility with a nondisplayed order book. Now, a year later, the exchange is still scrambling to line up partners that can deliver liquidity to its nascent trading venue.
“We’re currently in discussions with a number of large investment banks,” says John Wilson, Baikal’s CEO and a former head of European capital markets research at Lehman Brothers who joined the LSE in October 2008 to take charge of the dark pool.
With Lehman gone the fact that Baikal made it off the drawing board is largely thanks to Wilson’s determination to realize the project. The initiative has also benefited from the unwavering support of the LSE’s new CEO, Xavier Rolet, who took the helm in May after serving as CEO of Lehman Brothers France, where he advised the exchange on the creation of Baikal.
The dark pool, named for the world’s deepest lake, in Siberia, is being rolled out in phases. In late June, Baikal introduced a “smart” order routing system that enables brokers to seek out the most cost-efficient trade execution by sending orders to 17 major European equity trading venues in 14 countries. The second phase of the launch, slated for November or December, will inaugurate the Baikal dark-order book nicknamed “Bob” by Wilson and his team. The book will seek to match larger block trades without posting them to a traditional “lit” exchange such as the LSE itself, where large orders are visible to other market participants who can potentially profit from the information they contain.
Baikal is entering a crowded field. Deutsche Börse created its own dark pool, Xetra MidPoint, last year, and NYSE Euronext launched SmartPool in February. Europe already had several other providers offering their matching services to institutions, including Instinet BlockMatch, Liquidnet Europe and Nyfix Euro Millennium.
Still, the market opportunity is significant. Approximately 10 to 15 percent of all trading activity in Europe is executed in dark pools, CEO Wilson estimates. That translates into £5 billion ($8 billion) to £8 billion worth of daily trades that are up for grabs.
Despite the competition, Wilson is confident that Baikal can succeed. Once fully operational its platform will help aggregate liquidity by allowing brokers to search other dark pools to find a match while protecting the anonymity of their clients’ orders. Baikal will even help navigate brokerages’ internal dark pools.
One of the platform’s biggest edges, though, may be its ability to insulate participants’ orders from being gamed by traders who use information gleaned from dark pools for competitive advantage. Baikal’s model features randomized match intervals to prevent market timing, and it specifies minimum order values to thwart traders who try to place small, spurious orders just to see if they get filled, a practice known as “fishing.” Participants can, for example, opt to trade only with other, more patient counterparties through Baikal’s periodic auctions, which will cross resident orders every one to 30 seconds, or they can elect to trade in a continuous crossing function while still staying protected from fishing and other efforts to game the platform.
“Baikal is offering a dark facility with a difference,” says Miranda Mizen, a principal at TABB Group, a capital markets research and advisory firm with offices in New York and London.
Nonetheless, Baikal’s future depends on buy-ins from big brokerage firms. “Even though those investors will hold only a minority of the equity, they’ll be crucial to the success of Baikal because they’ll be able to direct order flow onto the platform,” notes Wilson, who hopes his conversations yield firm commitments from three to five major banks. In a world awash in dark pool alternatives, his challenge is clear: to convince traders that Baikal’s platform can live up to its name — and become both deeper and darker than the competition.
