Playing to Strengths
The team-ups between beleaguered banks and ascendant electronic firms plays to the strengths of both the big institutions and the leaner, newer entrants, said Joe Gawronski, president and chief operating officer of Rosenblatt Securities.
“The banks have the customer relationship, but the electronic guys are great at the technology and risk management,” Gawronski said. “There’s potential for a good marriage there.”
The niche that firms like Virtu and GTS are filling is a vital part of finance known as market making. A middle man buys from sellers and sells to buyers, and in the process makes money from the difference in price. Market makers aren’t trying to predict which way markets are headed -- they just provide liquidity to those who want it. These intermediaries aim to end every trading day with no risk, or with their exposures fully hedged using derivatives or other means.
The power shift is nearly complete at the New York Stock Exchange. Four electronic market-making firms now oversee almost all trading on the historic floor -- outposts that once belonged to investment banks like Goldman Sachs Group Inc. and Bank of America Corp. This year Citadel Securities and GTS each purchased a so-called designated market maker operation, joining Virtu and IMC in managing listed companies’ stock there.
While equity markets have mostly moved to electronic trading after beginning to shift in the 1990s, other asset classes are still in transition, making them targets for computerized trading firms. The movement toward electronic markets offers money managers a chance to have more control over how their orders are carried out, said Nanette Buziak, head of equities trading at Voya Investment Management, which oversees $204 billion in assets. Electronic firms are poised for new opportunities in foreign exchange, Treasuries and fixed income, she said.
“They’re the market makers now,” Buziak said. “You’ll see new partnerships going forward in other asset classes. We’ll see more consolidation as well.”
Flash Crash
The new order is not without risks. The flash crash of May 2010, which erased more than $800 billion of value from U.S. stocks in minutes, illustrated the dangers that can arise as algorithms come to dominate financial markets. Computer-driven trading strategies can be easier for cheaters to fool and manipulate. British trader Navinder Singh Sarao was arrested and charged by the U.S. government for making millions of dollars manipulating futures markets from his bedroom. He’s denied he did anything wrong.
Meanwhile, regulators have struggled to keep pace with the faster-moving computerized landscape. The U.S. Securities and Exchange Commission has moved slowly for more than six years on a plan to better understand stock market mishaps like the flash crash. The regulator’s plan for a gigantic repository tracking billions of daily orders and quotes, called the Consolidated Audit Trail, is nowhere near ready. No contractor has been picked to build the system yet.