Block Trades Disappear in U.S. as Volatility, Losses Increase

By Edgar Ortega

Nov. 24 (Bloomberg) -- Block trades, dwindling in the U.S. for a decade because of electronic markets, have all but disappeared as the credit crisis and near-record volatility dissuade investors from selling equity in chunks.

Transactions of 10,000 shares or more at the New York Stock Exchange have dropped by half since 2006 as investors avoided the risk of getting whipsawed by price swings. Block trades, which banks sometimes facilitate by purchasing shares from investors and then selling to clients, represented 9.4 percent of volume on Nov. 17, the lowest since the credit crisis intensified in September, according to data compiled by Bloomberg.

“There’s going to be a continuing shrinkage of trade sizes because of the increasing amount of trading that’s done electronically,” said Dennis Fox, head of trading at Munder Capital Management Inc., which oversees $15 billion in Birmingham, Michigan. “You have a reluctance by a lot of people to trade in size. A lot of traders are afraid to be wrong.”

Brokerages are shying away from using their own capital to finance transactions to avoid potential losses from price swings before they can complete the deal. That’s forcing investors to rely on computer-driven strategies that split orders into pieces. Volume at Zurich-based Credit Suisse Group AG’s algorithmic- trading unit has more than doubled this year. Firms including BNY ConvergEx Group and Liquidnet Inc., New York-based companies that never use their own money for trades, are drawing business from Wall Street firms.

1929 Record

The magnitude of U.S. stock market swings will soon surpass the record set in 1929 as the 80-year-old Standard & Poor’s 500 Index heads for it steepest annual loss, Krag “Buzz” Gregory, a derivatives strategist at Goldman Sachs Group Inc., wrote in a Nov. 21 report. Realized volatility, a gauge of stock-price moves, for the S&P 500 has risen to 66 percent for the last three months, the highest since reaching 68 percent following the crash of 1929, he added.

Smaller orders are driving the surge in volatility, according to traders including Louis Matrone at Rushmore Investment Advisors Inc.

“Everything is trading in smaller and smaller pieces and that’s part of the reason that we have such volatility,” said Matrone, director of trading at Plano, Texas-based Rushmore, which managed $859 million on Sept. 30. “There is no one to say, ‘I buy shares here.’”

As recently as 2000, blocks at the NYSE represented 42.9 percent of volume in stocks listed on the exchange, according to data on its Web site. With the increasing use of algorithms, blocks waned to 21.3 percent of volume in 2006 and 9.8 percent this year.

Need for Blocks

Blocks for Nasdaq Stock Market companies accounted for 12.8 percent of volume in 2008, compared with 18.7 percent in 2006, exchange data show. They represent 0.1 percent of transactions this year.

Regardless of volatility, traders will always have a need for blocks, said Dan Mathisson, head of Credit Suisse’s algorithmic unit.

“I don’t think there is any permanent structural change in terms of proportions of algorithms versus blocks,” said Mathisson. “There is always going to be a need for immediacy, meaning a trader that has to move a large position now. That kind of immediacy can only be supplied by block desks committing capital.”

Block Talk

NYSE Euronext, the New York-based owner of the biggest exchange by value of listed companies, introduced Block Talk four months ago in a bid to resurrect the trades. The system allows floor brokers to electronically find others interested in executing large orders. The NYSE also hopes to win regulatory approval in January for the New York Block Exchange, a joint venture with New York-based Bids Trading LP. The so-called NYBX will connect NYSE members and Bids Trading clients, who send orders for some 3 billion shares daily.

“While institutions embrace electronic trading, their most common complaint is an inability to get size done and find block liquidity,” Joseph Mecane, NYSE Euronext’s chief administrative officer for U.S. markets, said in a Nov. 20 interview. “Block trading is a big piece of what differentiates us from the other markets.”

Wall Street trading desks, stung by $708 billion in losses from mortgage-related debt, are paring back the use of capital to facilitate orders because volatility made those bets riskier.

Value at Risk

Merrill Lynch & Co. cut its stock positions last quarter, dropping its value at risk -- a statistical estimate of how much it could lose in one day -- to $16 million from $28 million a year earlier, according to regulatory filings. Goldman Sachs Group Inc.’s VaR for equities fell to $67 million for the three- months ended Aug. 29 from $98 million a year earlier, regulatory filings show.

Thomas Garcia, head of trading at Thornburg Investment Management, said he hasn’t gotten a call from a broker offering to facilitate orders with their own money for about five months.

“For a while there, at the end of last year, I had firms calling all the time,” said Garcia, whose Santa Fe, New Mexico- based firm oversees about $35 billion. “I’d be pulling in the reins as well because of the volatility. Firms are definitely watching their balance sheet more closely.”

That’s given firms such as BNY ConvergEx and New York-based Instinet LLC, which don’t risk their own money, an opening. So- called agency brokers increased their market share of trading by 13 percent in the third quarter compared with the previous period, according to Investment Technology Group Inc., which tracks more than $18 trillion of trades for pensions, mutual funds and asset managers.

‘An Antique’

With blocks fading from exchanges, brokerages that anonymously pair off large transactions are drawing more orders. At Investment Technology Group, which started its Posit electronic block system in 1987, volume is up 8.5 percent from a year earlier to a daily average of 209 million shares.

Daily volume at Liquidnet has increased 31 percent this year through September, compared with a year earlier, according to regulatory filings. The number of shares per transaction has averaged more than 50,000 since June, compared with fewer than 300 on U.S. exchanges.

“The business has moved into that anonymous alternative trading system world,” Robert Gasser, chief executive officer of New York-based Investment Technology Group who was once the head of block trading at JPMorgan Chase & Co., said Nov. 19. “That whole notion of the old block trading desk is an antique.”

To contact the reporter on this story: Edgar Ortega in New York at ebarrales@bloomberg.net.