What is a cross-trade?
A cross trade is a practice in which buy and sell orders for the same asset are netted without recording the trade on an exchange. It is not allowed on most major exchanges. A cross trade also occurs legitimately when a broker places combined buy and sell orders for the same security on different client accounts and reports them on the exchange. For example, if one client wants to sell and another wants to buy, the broker could combine these two orders without sending the orders to the exchange to be executed, but filling them as a cross trade and then signalling transactions retrospectively but in a timely manner. and with timestamps with the time and price of the cross. These types of cross trades must also be executed at a price that matches the prevailing market price at that time. cross trades are often executed for trades involving combined buy and sell orders related to a derivatives trade, such as hedging a neutral delta options trade.
How a Cross Trade Works
Cross-trades have inherent pitfalls due to the lack of adequate reporting involved. When the trade is not recorded via the exchange, one or both clients may not get the current market price that is available to other (non-cross) market participants. As orders are never publicly listed, investors may not be informed. that a better price is available. Cross-trades are generally not allowed on major exchanges. Orders must be placed on the exchange and all transactions must be recorded.
However, cross-trading is permitted in certain situations, such as when the buyer and seller are both clients of the same asset manager and the price of the cross-trade is considered competitive at the time of the trade.
A portfolio manager can effectively transfer a client’s asset to another willing client and eliminate the spread of the transaction. The broker and manager must demonstrate a fair market price for the transaction and record the transaction as a cross for proper regulatory classification. The asset manager must be able to demonstrate to the Securities and Exchange Commission (SEC) that the transaction was beneficial to both parties.
KEY POINTS
A cross trade is a practice in which buy and sell orders for the same asset are netted without recording the trade on an exchange. This is an activity that is not allowed on most major exchanges. A cross trade also occurs legitimately when a broker places matching buy and sell orders for the same security on different client accounts and reports them on the exchange. Cross trading is permitted when brokers transfer client assets between accounts, for hedging derivatives and certain aggregated orders.
Concerns About Cross Trades
Although a cross trade does not require each investor to specify a price for the continuation of the trade, matching orders occur when a broker receives a buy and sell order from two different investors who are both displaying the same price. Depending on local regulations, such transactions may be permitted, as each investor has expressed interest in completing a transaction at the specified price. This may be more relevant for investors who trade in highly volatile securities whose value may fluctuate significantly over a short period.
Cross-trades are controversial because they can undermine confidence in the market. Although some cross-trades are technically legal, other market participants have not had the opportunity to interact with such orders. Market participants may have wanted to interact with one of these orders, but the opportunity was not given because the transaction took place off-exchange. Another concern is that a series of cross-trades can be used to “paint the tape”, a form of illegal market manipulation whereby market participants attempt to influence the price of a stock by buying and by selling it to each other to create the appearance of substantial trade.
