Liquidnet has been designed to enable asset managers to trade large blocks of stock among themselves anonymously, without third party intervention, and with significantly reduced transaction costs. The new venture has been founded by Seth Merrin and Eric LeGoff, the team behind successful previous outings with Merrin Financial and Vie Systems, which were later sold to ADP and Neon respectively.

The arrival of Liquidnet has been welcomed by large institutions which are seeking to cut back on transaction costs and create an efficient distribution channel for large block trading.

"The explosive growth in assets under management combined with the decline in both average order execution size and capital expenditure from the street and specialists has exacerbated the need for a system like Liquidnet. The cost of executing large orders in today's market structure is unacceptable and we will pursue any alternative means of institutional sized liquidity. Liquidnet offers tremendous promise to that end," says Leo Smith, head trader, Putnam Investment Management.

Increased fragmentation along with an avalanche of retail order flow has reduced the average trade size on all trading venues. At the same time, assets under management and institutional order sizes have increased making it more difficult for buy side traders to execute their orders without affecting the market price.

"We see the problem of transaction costs growing. Some of these costs are inherent in the current market structure. One way to reduce some of these transaction costs is to go outside of the current market structure using a system like Liquidnet," says Andrew Brooks, head of the equity trading desk at T. Rowe Price.

Industry consultants have pegged the transaction costs-trade delay, missed trades and market impact at around $100 billion annually. According to the PlexusGroup, which compiled the figures, these costs have increased by an additional 15% in 2000.

Liquidnet says it will reverse the current paradigm in which traders have to search for liquidity, by instead alerting investors when liquidity is available. Members of Liquidnet will determine when to enter into a negotiation, how much to execute and at what price, says the company. Negotiations between members will be conducted one-on-one in an anonymous 'chat-room' environment without dealer intervention.

"According to the NYSE and Nasdaq, their average execution size is 1205 and 700 while their block trades were a little over 24,000 and 21,000, respectively. That's just not big enough for institutions who commonly have orders of 250,000 shares or more," says Seth Merrin, CEO of Liquidnet. "With many institutions trading multiple million-share blocks, the large institutional brokers are unable or unwilling to commit the kind of capital to make a difference in providing liquidity. Today, the only firms who can provide the liquidity required by these institutions are other institutions."

The Liquidnet desktop application is currently being rolled out to over 100 institutional firms and live trading is expected to begin some time in the first quarter.