Cross Trade

A cross trade is a practice in which a trade on the asset is offset. Though exchange platforms do not permit cross-trading, it can be legally executed when a broker matches a buy and a sell order for the same security across two separate client accounts. It is then executed through the respective exchange, getting recorded as a cross trade. 

Key Takeaways  

Cross Trade Example 

Now that the cross-trade definition is clear, let’s look at an example. Suppose a client wants to sell a certain security while another wants to buy it. A broker can easily match both those orders without sending the orders back to the stock exchange to be filled. Instead, both orders can be filled as a cross trade, and the transactions can be reported in a timely manner such that they are time-stamped with both the time of the trade and the price of the trades on both sides. To be legal, this cross-trade must be executed at the price point that corresponds with the security’s market price at that time. 

Also Read, What Is Stock Exchange? 

When are Cross Trades Permitted?  

Typically, cross trades are not permitted on major stock exchanges, as orders must be sent directly to the exchange for recording. However, in select situations, cross trades can be permitted. Such is the case when both the seller and buyer are managed by the same asset manager. Another time in which a cross trade may be permitted is when the price of it is considered competitive at the time of the trade being carried out. 

A portfolio manager can - without difficulty - move one of the client’s assets to another that wants it, so they can eliminate the spread of the trade. Both the manager and the broker must prove a fair market price for the transaction and then record the trade as a “cross trade” so they follow the legally correct regulatory classification. The asset manager is required to show the exchange involved that the cross trade was beneficial to both parties. 

Certain other conditions for cross trades to be permitted are as follows: 

Who is Cross Trading For? 

Now that we understand what is cross trade meant for, who is the ideal candidate for it? While it isn’t necessary for investors involved in a cross trade to specify a price for the transaction to proceed, the only way an order can be matched by a broker is when she receives both a buy and sell order from two different investors who list the same trade price. 

Depending upon the regulations of the exchange, or SEBI, such trades may be permitted, as each investor has shown an interest in carrying out a transaction at a specific price point. Hence, this type of trade may be more relevant to investors who trade securities that are highly volatile. This is because the value of the security may dramatically shift in a short time. 

Understanding the Mechanics of Cross Trading

Cross trades may be risky as they do not go through the exchange in the regular way. If a trade is not recorded on the exchange, the buyer or seller may not get the true market price at that moment.  

Also, investors do not get a chance to see if the trade was available at a better price, as these trades are not visible to the public. This lack of transparency is one of the biggest reasons why cross trades are not allowed in the major exchanges. Every order must be sent to the exchange and recorded for fairness. 

However, it is vital to know that cross trades are allowed in a few specific situations. One common case is when both the buyer and the seller are clients of the same asset manager. If the price offered is competitive with the current market price, then trading can be permitted. 

In such cases, assets can be moved from one client to another by the portfolio manager, eliminating the buying and selling spread. However, strict rules still apply. It is vital for the broker and the manager to prove that the trade was done at a fair market price. They also need to classify it correctly as a cross trade. Most importantly, the asset manager must show regulators that the trade was fair and beneficial for both clients involved. 

Also Read, What Is CMP in the Stock Market? 

Pitfalls of Cross Trading 

There are some inherent pitfalls when it comes to cross trading. The main reason they become problematic is due to a lack of proper reporting. When a trade does not get recorded through the exchange, either or both clients may not be able to buy or sell at the prevailing market price, which is available to non-cross trade traders. As cross-trade orders are, by definition, never publicly listed, investors may not become aware of whether a better price is available. 

Another reason cross trading is considered controversial is that it potentially undermines the trust in a market. Some cross trades are technically considered legal, even while other market participants are not given the chance to interact in these orders. Market participants may have wanted to take part in some of these orders, but were not given the opportunity to since the trade occurred off of the publicly listed exchange, making the transaction somewhat unfair. 

A final concern is that multiple cross trades can be used to give the illusion of substantial trading activity around a security, which can eventually influence its price. This is called ‘painting the tape’: a manipulative tactic to affect the market price of a certain security via illegitimate means. 

Exploring Risks and Controversies in Cross Trades 

Investors do not need to set a fixed price for cross trades,  but the broker can match the trade only when both buyers and sellers list the same price. In cases where both investors willingly agree, trades can be done under certain rules. Cross trades are often more useful for people dealing with highly volatile securities, where prices can change very quickly. 

However, cross trades can also be controversial. They may not be entirely successful in winning market trust as they do not take place on the exchange. This means other traders never get the chance to see or react to those orders, even if they might have offered a better price. Since the trade is not public, there may be a feeling of unfairness  for other market participants. 

Another major concern is market manipulation. Cross trades can sometimes be used to “paint the tape,” which means creating the false appearance of heavy trading activity to influence a security’s price. 

Conclusion