DAVOS NEW TRADING FIRMS
TRADING GIANTS
NEW KIDS ON THE BLOCK
Trading giants
As the new trading venues around Europe grab the headlines, little attention is being paid to the liquidity
providers from the US lurking in the shadows that could make or break these fledgling operations.
WRITER Michelle Price
T
he European cash-equities stage, inflamed as it
has become by competition in the wake of Mar-
kets in Financial Instruments Directive
(MiFID), is already a little overcrowded. During
the past 18 months, a slew of new, frequently indistin-
guishable trading venues have entered the marketplace
with fierce public commotion and variable success.
These include Instinet-owned Chi-X Europe, widely
regarded as runaway success, and NYFIX Euro Millen-
nium, both of which have been operational for some
time, while August 2008 brought the long-awaited take-
off of bank-backed platform Turquoise. Nasdaq OMX
Europe began operations in late September, and BATS
Europe, whose US platform commands 10.6% of the
market, launched on October 31. Waiting in the wings
are Börse Berlin-owned Equiduct Trading and the
Nordic contender Burgundy, while both the London
Stock Exchange (LSE) and Knight Capital Group, a US-
based agency broker, have unveiled plans to launch dark
liquidity pools.
But while the spotlight has been very firmly fixed on
the arrival of these new publicity-hungry contenders, lit-
128 | THE BANKER | January 2009
tle public discussion has been devoted to the often-
inscrutable entities that will ultimately decide their fate:
liquidity providers. For the success of these trading ven-
ues will be determined by their ability not only to wrestle
established liquidity away from the incumbent
exchanges, but also by how successful they are in attract-
ing new liquidity provided by trading firms, whose
names and trading strategies are largely unfamiliar to
the European market.
Hailing principally from the US, these firms – com-
prising proprietary trading desks, hedge funds and bro-
kerages – have played a quietly transformative role in
their native markets, and are now eyeing Europe as their
next destination. Many market-watchers believe that
these firms, having fast gained a formidable presence in
the US markets, will play a powerful role in determining
not only who wins the battle for European liquidity, but
the shape of European landscape in years to come.
REVISING THE ROLL-CALL
So who are these invisible firms? In answering this ques-
tion, it pays to look closely at the investors behind two of

ROSENBLATT EUROPE ESTIMATES THAT
[HIGH FREQUENCY TRADING FIRMS]
COLLECTIVELY ACCOUNT FOR 50% TO
60% OF US EQUITY TRADING
VOLUMES Justin Schack
the most successful upstart trading platforms launched
to date. Take Chi-X Europe, which has secured about a
14% market share of the FTSE 100 stocks and BATS
Trading, the third largest market in the US, as key exam-
ples. Beside what was once upon a time the familiar roll-
call of blue-blooded Wall Street brands, including
Merrill Lynch, Morgan Stanley and Citigroup, are some
less recognisable names including Global Electronic
Trading Company (GETCO), Lime Brokerage, Optiver,
Tradebot and Wedbush Morgan Securities (WMS).
These firms and their publicity-shy peers and clients
– which often hail from regions that would be described,
at best, as peripheral to the world of global finance,
including South Carolina, Kansas and Los Angeles –
form part of a new wave of so-called ‘high frequency’
speed-sensitive traders that have come to dominate US
equities in recent years. Frequently young, secretive, pri-
vately held and ambitious, the importance of these high-
frequency trading firms, which may often number only
six or seven people in size, is not to be underestimated.
Rosenblatt Europe estimates that these firms collectively
account for a staggering 50% to 60% of US equity trad-
ing volumes on an annual basis, according to Justin
Schack, vice-president of the agency broker.
Edward Wedbush, president and CEO of Los
Angeles-based WMS, which is among the largest inde-
pendent brokerage firms in the US, knows better than
most just how “huge”, as he puts it, such high frequency
players have become in the US marketplace. WMS,
which originally served as BATS Trading’s chief clearing
agent, provides transaction, trading and clearing serv-
ices to a broad range of statistical arbitrage traders and
automated market makers. “Through computer-assisted
trading, these clients provide the liquidity that is funda-
NEW TRADING FIRMS DAVOS
TRADING GIANTS
mental to the market,” he says. Few would anticipate that
WMS, as a provider of execution services to these high-
volume clients, has ranked as the number one liquidity
provider to Nasdaq for the past three years.
Founded in 2001, New York-based Lime Brokerage
has also built a business catering to the demanding
requirements of these ever-important trading houses.
Among the original three backers of BATS, Lime Broker-
age, which also has a minority stake in the Chicago Board
Options Exchange’s stock exchange, styles itself as a
super high-tech agency broker. It caters to clients that, as
the firm’s newly appointed CEO Jeff Wecker puts it, “are
uniquely sensitive to speed of execution”. The firm exe-
cutes hundreds of millions of shares a day on behalf of
these clients, touching a sizeable 5% of all traded vol-
umes in the US equities market daily.
Impressive though this may be, such volumes are
small change compared with those pumped out by high-
frequency players trading on their own account – GETCO
being the most notable example. The low-profile, high-
frequency automated market maker, which was an early
investor in BATS Trading and a backer of Chi-X Europe,
uses automated electronic systems to trade more than
one billion shares a month, according to a 2006 Securi-
ties and Exchange Commission (SEC) filing.
Trading on such a vast scale, GETCO and its peers
are believed to have played a fundamental role in reshap-
ing the US equity market structures. But unlike many
investment banks, the firm passionately eschews ego-
driven, short-termist individualism of the sort that has
traditionally been characteristic of City trading floors.
“We believe that a low-ego, team-oriented culture fuels
the kind of continuous innovation that is critical to our
success,” says Dan Tierney, co-founder GETCO. Never-
theless, its rumoured market value gives cause for some
self-satisfaction. In April 2007, General Atlantic, a pri-
vate equity firm, purchased a 20% stake in GETCO in a
deal that valued the firm somewhere in the region of
$1bn to $1.5bn, according to The Wall Street Journal.
MAKER TAKER MODEL
Firms such as GETCO or leading Dutch market maker
Optiver, another Chi-X backer, add liquidity to the mar-
kets by using high-speed algorithms to flood venues with
bid and offer orders on particular stocks. Although such
firms profit on the spread – which may often total a mere
penny or less – the success of this strategy depends
largely on the so-called ‘maker taker’ fee model which is
increasingly being adopted by US and new European
execution venues in order to attract liquidity. Under this
fee structure, liquidity providers (that is firms that either
post an order to buy or sell at a fixed price) are offered a
rebate if their quotes are met. Chi-X Europe, for exam-
ple, pays a 0.2 basis point (bp) rebate to firms that com-
mit to posting quotes on its platform, while it charges
takers of liquidity (firms that hit these orders) 0.3bp.
High-frequency market makers collect this rebate
hundreds of thousands of times a day. “The rebate is a big
proportion of the profit and loss that they drive from that
market activity,” says Dmitri Galinov, a director at Credit
Suisse Advanced Execution Services. Frequently, the
January 2009 | THE BANKER | 129
DAVOS NEW TRADING FIRMS
TRADING GIANTS

daily value of the rebate will offset the profit and losses
on the firm’s trading account. “Overall they may have lost
money trading but will make money due to the rebate,”
says Gary Wedbush, head of capital markets at WMS.
For all parties concerned, profits are derived from wafer-
thin margins ramped up to a colossal scale.
Unlike automated market makers, however, statisti-
cal arbitrage players operate by analysing vast quantities
of market data from which they identify and exploit inef-
ficiencies in the pricing of securities. Typically, these
firms take on very little leverage, carry little risk and fin-
ish the day flat. But the difference between the two
strategies is becoming less perceptible, says Gary Wed-
bush. “There is definitely a blurring between these two
strategies, as many statistical arbitrage strategies depend
on receiving the rebate,” he adds.
Due to their growing scale, many statistical arbitrage
players have become key liquidity providers to the mar-
kets that they operate in and, as such, play a similar role
to their automated market making peers. Hedge funds
including New York-based Tower Research Capital LLC,
a close affiliate of Lime Brokerage, and global giant
Citadel, which accounts for 16% of the European market
according to one source, are both in this league. Other
proprietary firms trading on their own account, such as
Chicago-based Sun Trading and Kansas-based Tradebot,
have become equally influential and compete head-on
with the world’s largest trading organisations. Both
declined to comment.
BEYOND THE SPEED OF THOUGHT
Founded in 1999 by technology enthusiast Dave Cum-
mings, Tradebot is regarded as one of the original
‘black-box’ trading powerhouses. Mr Cummings, the
company’s CEO, also founded BATS Trading, of which
he is former CEO and in which he owns a major stake.
Like BATS, for which in the words of one source, out-
sourcing is regarded as “blasphemy”, Tradebot designs
and builds all its technology in house. The firm is an
active liquidity provider on the major US exchanges and
electronic crossing networks, including Nasdaq, NYSE
Arca, BATS and Direct Edge, where it moves in and out
of stocks at breakneck speed. For Tradebot, as with the
above firms, the fundamentals of a stock are rarely, if
ever, relevant.
Instead, the key is low latency. For firms such as
Optiver and Tradebot, speed is not just everything: it is
the only thing. Take Nasdaq, one of the faster US mar-
kets. Every time the exchange receives an updated quote,
explains Chris Concannon, executive vice-president,
transaction services for Nasdaq OMX Group, more than
five firms are able to receive that information and update
their quotes accordingly in about half a millisecond.
“They are now first in line for execution. So when the
next incoming order comes in, the first of those five firms
gets it first: they’ve just got priority over the entire mar-
ket at that price,” he says. By the time it gets to the fifth
firm, the spread will have moved.
Low latency is therefore about being at the front of
the queue. Firms such as Tradebot are able to send and
receive orders in less than one-thousandth of a second:
NOW THESE TYPES OF HIGH-
FREQUENCY TRADERS HAVE GOT
A NATURAL PLACE IN WHICH TO
TRADE IN EUROPE
Mark Hemsley
put another way, they are able to trade about 200 times
faster than the average speed of thought. In a bear mar-
ket, these micro-fractions matter more than ever: the
potential value of a millisecond was vividly demon-
strated during a particularly bloody period on Black Fri-
day, October 10, 2008, when the UK market plummeted
at a hair-raising £250m ($370.5m) a second. When sell-
ing in such conditions, a millisecond matters. For some
large firms, a one-millisecond advantage could even be
worth up to $100m a year.
AT THE FIREWALL
But it is not enough for the firms themselves to be fast.
Once they are at the exchange’s firewall, they are depend-
ent on the speed of the exchange or execution venue
itself. Because the fastest trading firms can do the most
business on the speediest exchanges, the latter are in a
position to garner the most liquidity from this new wave
of players. Hence the unseemly cat fight that has
unfolded in Europe regarding low-latency statistics: for
firms such as BATS and Chi-X Europe, technology capa-
bility has formed the central plank of their marketing
campaigns as they hope to court this new breed of trader
– a pursuit which, at least in the case of Chi-X, has so far
proved successful.
Meanwhile, incumbent platforms, such as the LSE,
are trying to catch up. According to its own figures,
BATS’ statistical average latency – which it defines as the
time from which an order hits its firewall until the time it
goes back through its firewall – is 444 microseconds, that
is 444 millionths of a second. Compare this to the LSE,
whose latency is at just under five milliseconds, or five
thousandths of a second. For the incumbents, however,
there might yet be a saving grace. Trading at high speed

130 | THE BANKER | January 2009


[HIGH-FREQUENCY TRADING
COMPANIES] ARE BRINGING TO
EUROPE A RANGE OF BATTLE-TESTED
ALGORITHMS AND REPURPOSING THEM
FOR THE EUROPEAN LANDSCAPE
Bradley Duke
and on a grand scale is a truly transformative exercise,
which tends to incubate more overall volume. In the US,
says Mr Schack, the volumes “exploded” when the high-
frequency players pitched up.
Transformation does not end here. Many of the new
breed of traders, in particular GETCO, Optiver, Tradebot
and Sun Trading, regard themselves as positive (albeit
profitable) forces in the equities markets. By deepening
liquidity, they serve to reduce the average spread
between the bid and offer on the equities that they trade,
thereby making the markets more efficient for retail and
institutional investors. In its 2006 letter to the SEC,
GETCO made this point quite explicitly. Between 2000
and 2006, the spread on Microsoft (a popular liquid
stock for such firms) tightened from $0.03 to $0.01, a
contraction that equates to a $300m saving in a trading
year of 240 days, wrote Stephen Schuler, GETCO’s co-
founder and CEO. Indeed, GETCO’s goal, says Mr Tier-
ney, “is to constantly improve our processes, create
greater efficiencies in the marketplace, and reduce the
cost of risk transfer for all investors”.
But this also equates to decreased profitability on the
spread. This would make Europe, as a far less efficient
market, an ever-attractive prospect to such firms. Mark
Hemsley, CEO of BATS Europe, says that the European
landscape, in terms of technology capability, the move
towards the ‘maker taker’ model, and the decreased cost
of market access, has become more suited to their strate-
gies. “Now these types of traders have got a natural place
in which to trade,” he adds.
Furthermore, says Bradley Duke, director, head of
institutional, electronic sales in Europe at Knight Capi-
tal Group, another major liquidity provider to the US
market, the wideness of the European spreads presents a
NEW TRADING FIRMS DAVOS
TRADING GIANTS
huge opportunity for these firms. “They are bringing to
Europe a range of battle-tested algorithms and repur-
posing them for the European landscape,” he adds.
FROM HI TO LO
Lime Brokerage is one such player. Mr Wecker believes
that the climate in Europe is “ripe” for its service offering
and the firm is “looking quite seriously at the European
marketplace”, he continues. This interest stems, for the
most part, from client demand. “We would not move into
a marketplace if we didn’t have significant customer
interests to be active in that marketplace. The changes in
the European market structure are so profound that it is
creating new opportunities, particularly for smart elec-
tronic investors,” he says.
Several other firms are poised to make the jump,
while others, including GETCO, Citadel and Sun Trad-
ing, are already making their presence felt. Steve Grob,
director of strategy at trading connectivity provider
Fidessa, which recently launched a fragmentation index
in order to track the shifting behaviour of European liq-
uidity, says there is evidence that the volumes appearing
on new venues is a result of growing statistical arbitrage
activity. Certainly the LSE, which has recently altered its
tariff structure to attract more algorithmic traders, likes
to declare that it has benefited from a growth in arbitrage
trading. The beleaguered Deutsche Börse has reported a
similar effect.
For some, however, this looks like an expedient argu-
ment. As one source remarks: “If I were in their position,
I would say the same too.” Few could argue convincingly
that the pressure on Europe’s somewhat flabby incum-
bents is not growing. November, for example, brought
what has widely been regarded as the first casualty of the
trading platform battle, when SIX Group, operator of the
Swiss exchange, announced that it is to shut down SWX
Europe, its London-based blue-chip market, in order to
consolidate its operations on its Zurich platform. Mean-
while, the untimely collapse of Lehman Brothers may
have badly wounded the LSE’s defensive move to launch
Baikal, a European dark pool unveiled in June 2007, for
which the late investment bank was to act as a key tech-
nology provider.
The LSE’s difficulties underline more broadly just
how important the new breed of US-led traders may be
to the ever-thirsty European landscape in the wake of the
financial crisis. As the embattled investment banking
community finds itself desperately short of capital, the
once free-flowing broker extended leverage, which has
served to bloat cash equities trading volumes over the
past few years, grows ever-scarcer. This situation has not
been helped by the reduced appetite for risk demon-
strated by many bulge-bracket banks, a trend that
reportedly led JPMorgan Chase to scrap its 80-strong
global standalone prop desk in November. By contrast,
many high-frequency firms, due to the nature and speed
of their trading strategies, remain largely undeterred by
extreme volatility of the type witnessed in recent months
and, in some instances, have found it to their advantage,
says Lime Brokerage’s Mr Wecker.
Mindful of this shifting power base, both the LSE
January 2009 | THE BANKER | 131
DAVOS NEW TRADING FIRMS
TRADING GIANTS

and Euronext are reportedly making strenuous efforts

to engage with a number of Chicago-based high-
frequency market makers, in an attempt to bring their
liquidity onto their markets. This strategy may yet prove
successful. For a number of US players, Europe’s
exchanges certainly seem to hold some appeal, although
firms such as WMS are looking further afield to
Europe’s emerging eastern contenders. WMS, which is
not a member of the LSE, is in the process of joining the
intensely ambitious Warsaw Stock Exchange. The US
brokerage was drawn to the Polish trading venue by
what Edward Wedbush describes as its “aggressive use
of technology” and the expectation that high-frequency
electronic trading is due to take off in the region in the
near future.
Research by Tony Kirby, co-chair of industry associa-
tion Best Execution Working Group, indicates that this THE REBATE IS A BIG PROPORTION OF
prediction is well placed: “The hedge fund market mak-
ers have a very strong appetite to interact with the new THE PROFIT AND LOSS THAT [HIGH-
multilateral trading facilities – particularly those in FREQUENCY MARKET MAKERS] DRIVE
which they maintain a stake.” His findings also suggest
that the ratio of this type of ‘lo-touch’ to ‘hi-touch’ trad- FROM MARKET ACTIVITY
ing in Europe will increase from a 30-70 split in 2008 to Dmitri Galinov
reach almost a 40-60 split by 2010, with just less than
one-third of European liquidity supplied by high-
frequency, ‘lo-touch’ trail-blazers.
In the worst of times, however, when credit has been
UNCERTAIN SURVIVAL short on quantity and high on cost, the complexity of the
Yet, the extent to which these US high-frequency firms emerging European clearing and settlement infrastruc-
can succeed in the tangled European market remains ture has become an even greater burden, says Mr Fuller.
uncertain. Bob Fuller, former CEO of Equiduct and now Because, on some of the new trading venues, the CCP
CEO of Exchange Axis, a neutral virtual broker, warns does not take on the risk of the trade until end of day,
that Europe’s intricate clearing and settlement infra- trading firms may need to secure already-costly credit
structure may yet trip up US firms entering the Euro- lines in order to cover the trading day risk with the orig-
pean marketplace. Unlike in the US, where the inal counterparty.
Depository Trust and Clearing Corporation (DTCC) acts “Trading across multiple trading venues in the
as the single central clearing counterparty (CCP) for all absence of a single CCP, such as the DTCC in the US,
equities transactions on all trading venues, the pan- could multiply the cost of clearing services even though
European market is littered with CCPs and 23 central their overall positions are flat,” adds Mr Fuller. In the
securities depositories. Even in the best of times, this is current market conditions, those venues offering real-
widely regarded as an unsatisfactorily complex and inef- time or intra-day novation – the point at which the CCP
ficient post-trade infrastructure. intercepts the trade and takes on the transaction risk –
may benefit, at least in the short-term, from higher trad-
ing volumes.
Despite the hardly trivial post-trade challenges
found in Europe – which may soon be resolved with the
imminent arrival of the DTCC in Europe – many market
Electronic order book trades in major
stocks %, November 2008 watchers are optimistic that the new breed of high-fre-
quency trader will be able to profitably make his mark
nonetheless. “The statistical arbitrage community and
■ Other 27.98% high-frequency quant-fund community represents
■ LSE 21.99% some of the most savvy electronic investors,” says Mr
■ Xetra - Germany
14.82% Wecker. And, as such, adds another source: “They’ve
■ Paris - Euronext done their sums.”
14.25%
■ Chi-X 9.49%
■ SWX Europe
% The Banker understands that some firms are still
assessing which models will best suit their scale and
technology capability, and it may be some months before
7.81%
■ Turquoise 3.35% they are ready to enter the market. Bashful as these
■ BATS 0.29% organisations tend to be, however, the story of their
■ Nasdaq 0.02% future impact on Europe will be told by the very public
Source: Fidessa rise and fall of their hopeful suitors. TB

132 | THE BANKER | January 2009