What is a block house?
A block house is a brokerage firm that specializes in matching potential buyers and sellers for large-scale operations.
Generally, a block house deals with institutional clients rather than individual investors. A single operation can represent millions of dollars in assets.
- Block houses are brokerages that primarily deal with large block deals between institutional investors.
- By definition, a block trade is more than $ 200,000 in bonds, or 10,000 shares, not including penny stocks.
- Block exchanges are made directly between buyers and sellers, not on public exchanges.
How a block house works
A block house, like any brokerage firm, facilitates transactions between buyers and sellers. You earn money from the commissions and other transaction fees you charge for doing that.
Unlike most brokerage firms, block houses primarily deal with so-called block trades. By definition, a block trade exceeds $ 200,000 in bonds or 10,000 stocks, not including penny stocks. In practice, block operations are usually much larger than that.
The actual transaction is between the parties, and the brokerage house acts as an intermediary, rather than in a public exchange.
The role of the Block House
Bulk trades are done off-exchange out of necessity. However, a very large order to buy or sell a particular stock will disrupt trading and artificially inflate (or deflate) its market price.
For this reason, block exchanges go through block houses. A block house can divide the trade into smaller chunks and funnel them through separate brokers to keep market volatility to a minimum.
That being said, even well-executed block trades can have a significant impact on the market, with some analysts looking at the activity of block trades to anticipate market trends. For example, if a mutual fund manager moves to acquire a large number of stocks in the entertainment industry, analysts may see this as a possible uptrend for leisure stocks in the near future.
Institutional clients of Block Houses include corporations, banks, insurance companies, mutual fund companies, and pension funds.
The Block House Alternative
Institutions looking to avoid brokerage fees and commissions can also directly block trades, without employing a block house as an intermediary, in the fourth market.
While the primary, secondary and third markets are public exchanges accessible to all investors, the fourth market is more exclusive and less transparent. Trading is restricted to institutions and transactions are only made public once they are completed.
This last characteristic of the fourth market is the greatest advantage for institutions that initiate block-size operations. Eliminate the risk of the market price rising dramatically before the transaction is completed as other investors pile in.
The potential of insider trading
The fourth market also excludes the possibility of a block house trader using knowledge of an impending block trade to participate in a fraudulent practice known as front running.
In 2013, a senior stock trader at Dallas-based Cushing MLP Asset Management was caught conducting his own trades immediately before his company’s clients’ block trades took place and stock prices rose. they were buying.
His plan benefited him at least $ 1.7 million over the course of 400 transactions. This was insider trading. Worse, he put his own interests in opposition to those of his clients, who specifically relied on him to manage their price exposure.
Block house trading example
Suppose a hedge fund owns one million shares of ABC and decides to sell it.
ABC typically trades about 200,000 shares a day. A block trade of this size couldn’t go through a public stock market without drastically altering ABC’s trading pattern for the day. And that could prove costly to the hedge fund. Instead, ABC decides to work through Cantor Fitzgerald, a block house brokerage.
The hedge fund operator will message a Cantor Fitzgerald sales professional looking for ABC buyers.
The hedge fund will not immediately disclose that the 1 million shares are for sale. Instead, it says there are 100,000 shares available. That brings in more potential buyers.
Sales professional alerts traders that 100,000 ABC shares are for sale. Merchants approach their contacts to gauge interest.
Eventually, the hedge fund and a buyer or buyers will reach an agreement.