What it means
Instinet was founded in the late 1960s at a time when large institutional investors, such as pension funds and mutual funds, were frustrated by the cost and visibility of trading on exchange floors. Its early systems let them find counterparties through a computer network.
This made it one of the first electronic trading venues, years before electronic trading became normal. The idea behind it was to cut the cost and the market impact of big trades.
When a fund wants to buy a very large block of shares, the news can push the price up before the order is complete. Trading in a more private, electronic setting reduces the chance that other traders spot the order and trade ahead of it.
As an agency broker, Instinet earns commission for executing trades and does not take positions against its clients. That structure matters because it removes the conflict of interest faced by brokers who also trade for their own account.
Clients use it for execution services, trading technology and analysis of their trading costs. Over time the company changed hands several times, and it is now part of the Nomura group.
The broader significance is historical, since it helped establish the electronic communication networks and alternative trading venues that now handle a large share of equity trading. A nuance for readers is that the name is often mentioned in older finance texts as an example of a third market or an electronic communication network.
Today the same functions are spread across many venues, so the brand matters less than the idea it demonstrated. Electronic venues also changed how trading costs are measured.
Investors now compare the price they obtained with a benchmark such as the average price over the day, and the gap is called implementation shortfall. This kind of analysis, which Instinet and similar brokers helped to popularise, is now a routine part of how asset managers judge their brokers.
In practice
Real-world examples.
Example
A pension fund needs to sell 2,000,000 shares of a mid-sized company. Its trader uses an agency broker's electronic platform to work the order in small pieces over the day, so the price does not drop on news of a large seller.
Example
A hedge fund compares execution costs across brokers. It chooses an agency-only firm because the broker has no trading desk of its own that could profit from seeing the fund's orders.
Example
A finance professor uses the history of Instinet in a class on market structure. She shows how electronic networks reduced trading costs and forced traditional exchanges to modernise. Her students learn that the technology was valuable mainly because it lowered the cost of finding the other side of a trade. He adds that the lower cost also benefits the pension holders whose money the fund manages.
Case study
Seen in the real world.
Ridgeline Asset Management is an illustrative, fictional fund that manages $4 billion for retirement savers. Its portfolio manager wanted to sell a $60 million holding in a thinly traded share without moving the price.
The trading desk split the order across an agency broker's electronic platform and several other venues, releasing small amounts through the day. The analyst measured the result against the average price over the day and found that the sale cost about 0.10% in market impact, or 60,000,000 x 0.001 = $60,000.
A traditional block trade negotiated by phone had been estimated at 0.40%, or $240,000. In this illustrative story, the saving of $180,000 was credited to the desk's use of electronic execution and to the discipline of working the order slowly. The saving, expressed as a share of the original holding, was small, but across a year of large trades such differences become a meaningful part of a fund's performance. The head trader added that the choice of venue mattered less than patience, because forcing a large order through quickly would have erased most of the benefit.
Watch out
Common mistakes.
- Treating Instinet as a stock exchange, when it is a broker and trading technology provider that connects to exchanges and other venues.
- Assuming that an agency broker trades against its clients, when the whole point of the agency model is that it only executes orders.
- Thinking of it as a current industry leader, when its main significance is as an early pioneer of electronic trading.
Questions
People also ask.
What does agency broker mean?
It means the broker executes trades on behalf of clients and earns a commission, rather than buying and selling for its own account.
Why did institutions want electronic trading?
They wanted lower commissions and less visibility, so that large orders would not move the price against them.
Who owns Instinet today?
It forms part of the Nomura group, a Japanese financial services firm.
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