What Is a Block House?
Block house are brokerage company that is specialized in bringing potential buyers together with sellers in large-scale transactions.
In general, a block house is more focused on institutional clients than individuals. One transaction could be worth millions of dollars of assets.
How a Block House Works
Block houses, just like any brokerage company is a facilitator of transactions between sellers and buyers. It earns money from charges for commissions, as well as other fees that it charges for doing this.
Contrary to the majority of brokerage companies they specialize in what’s known as blocks trades. By definition, a “block” trade is one that exceeds $200,000 worth of securities or 10,000 shares, but not counting penny stocks. In reality Block trades tend to be more than that.
The actual transaction takes place between the two parties, with brokers acting as middlemen instead of the public exchange.
The Role of the Block House
Block trades happen off-exchange due to the necessity. A large-scale order for buy and sell certain stock could, however, accidentally cause disruption to trading and increase (or reduce) the price of its market.
Because of this, block trades are conducted via block house. Block houses are able to divide trading into more manageable pieces and then channel them through different brokers in order to keep the volatility of the market to the minimal.
However, well-executed block trades could have a significant impact on the market. Some analysts follow block trade activity to predict market developments. For instance, if an investment manager of a mutual fund decides to buy a substantial portion of the leisure sector analysts could consider it a possible trend upwards for stocks that are primarily leisure soon.
Block houses’ institutional customers comprise banks, corporations and insurance companies and mutual fund companies along with pension funds.
The Block House Alternative
Institutions looking to reduce commissions and brokerage fees could conduct block trades direct without the use of the block house as intermediary in the fourth market.
While the primary, secondary as well as third market are all public exchanges accessible to investors of all kinds The Fourth market tends to be more private as well as less transparent. Trading is only available to institutional investors and transactions only released when they have been completed.
The last aspect that is part of the fourth market offers the most significant benefit to institutions that are able to initiate block-size trades. This eliminates the possibility that the price on the market could be soaring prior to the transaction’s completion when other investors join in.
The Potential for Insider Trading
Fourth market eliminates an opportunity that blockhouse trader would use information about an imminent block trade to commit an illegal practice called front running.
In 2013 an equity trader in the senior position at the Dallas-based Cushing MLP Asset Management was discovered to be trading his own shares right before block trades from his clients’ clients were completed and raised the price of the shares they were purchasing. 1
The scheme benefited him by at the very least $1.7 million in the course of just 400 transactions. This was considered insider trading. It also put his personal interests against to the interests of his customers who specifically depended on him to control their risk exposure to prices.
Example of Block House Trading
Let’s say that a hedge fund holds millions of shares ABC stock. It decides to offer it for sale.
ABC generally trades around 200 000 shares per day. A block trade of this magnitude would not be able to go through an exchange that is public without radically altering the ABC trading pattern throughout the day. It could also be expensive for the hedge fund. In the end, ABC chooses to partner with Cantor Fitzgerald which is a block house brokerage.
The hedge fund will then send an email to a sales representative at Cantor Fitzgerald, looking for potential buyers for ABC.
The hedge fund isn’t going to immediately announce the fact that all one million shares are available for sale. Instead, it states that 100,000 shares are up for sale. This means that there are more buyers.
The sales representative informs buyers that the shares in ABC are available for sale. The traders contact the people they know to determine the interest.
At some point the hedge fund, along with buyers or buyers may conclude a deal.
