Blackrock is the largest money manager in the world, with $3.5 trillion under management.  It manages stock, bonds and alternative investments, packaged as either separate accounts, ETFs or mutual funds.  It was built by former brokerage house employees who come from a deeply trading-oriented culture.  So it’s not surprising that the firm has a keen awareness of the value of the trading it does with the rest of the financial world.

Blackrock first announced its intention to create an internal trading platform in 2009.  Recently the Financial Times reports that the firm has begun to hire IT people to have the network up and running sometime in 2011.

the platform

How will the trading platform work?

If I understand Blackrock’s plans correctly, it will be something like this:

1. All buy and sell orders for publicly traded securities anywhere in Blackrock will be  entered into the internal trading system.  Buys and sells that match one another will automatically be executed inside Blackrock, saving the majority of the commission that would otherwise be paid to a third party.  In this respect, the platform will work like an electronic crossing network.

2. Small orders can be aggregated and placed externally at a more favorable commission rate.

3. Minimum levels of order flow can be directed to brokers who will give a better rate in order to get higher volume.  Factors 1-3 would mimic the behavior of discount brokers.

4.  Unlike the case with third parties, portfolio managers will presumably give a true indication of the total intended size of any transaction, rather than feeding orders piecemeal to try to disguise their intentions.  This may allow managers to negotiate more frankly through internal Blackrock traders, and thereby buy and sell in large size much more quickly than they would be able to do otherwise.

Where will the trades come from?

…from ETF share creation/redemption and related hedging, mutual fund inflows and outflows, and the buy/sell decisions of active managers working for Blackrock.

only scratching the surface

When the trading platform is up and running and some record of savings from internal matching is available, Blackrock will likely begin to use the data as a marketing tool for its products.  I presume the marketing pitch will be that part or all of the savings will be returned to clients–producing better performance.  Maybe this will be enough to tilt a hiring decision in favor of Blackrock, maybe not.  But I think this is only the first use Blackrock will make of the platform.  For instance:

–understanding the aggregate patterns of the movement of Blackrock’s $3.5 trillion under management is a powerful source of market intelligence

–it can be a tool for evaluating the decision-making skills of the firm’s managers

–Blackrock can seek other sources of trading flow.

—–it could easily open its trading platform to others as a “dark pool.”

—–it could offer the platform to discount brokers.

—–it could create a discount brokerage operation itself.

What I think is most interesting about Blackrock’s plans is that the firm doesn’t need to make money from its trading operations.  It can even take a loss on trading, if it thought that would enhance the attractiveness of its fee-generating money management business.  This possibility should be very scary to financial firms whose chief/sole business is based on trading, especially for any with Blackrock as a big customer.  But the possibility has wider import.  The canyons of Wall Street are littered with the bones of one-product companies where someone else decided to make that product a loss leader.