New breed of trader heads for Europe
By Jeremy Grant
Published: December 3 2008 20:11 | Last updated: December 3 2008 22:41
A few weeks ago a team from the London Stock Exchange flew to Chicago on an unusual mission.
The Midwestern city is widely acknowledged as the birthplace of financial derivatives and home to the loud pit traders long emblematic of the trading world.
But the LSE was not scouting around Chicago’s futures exchanges. It was interested in meeting a new breed of trader that traces its origins to those same pits: a small but increasingly important group of electronic trading firms that have quietly built up a massive presence in the US equities markets.
Their strange-sounding names – Getco, Peak6, Archelon, Tradebot, RGM Advisors – have nothing in common with the long-established nameplates of Wall Street and City of London.
They are young – most little more than five years old – and are privately held. Some recruit mostly through private referrals from existing employees.
Liquidity inhabits a secret world
A degree of secrecy is the hallmark of the “global liquidity providers”. So much so that searching for information on their websites rarely reveals much beyond the firm’s name, mission and recruitment policy, writes Jeremy Grant.
That is hardly surprising because they do not have customers and are essentially privately held.
Peak6, one Chicago-based firm, does not even give a telephone number, although there is an e-mail address. The story is similar with EWT Trading, with offices in Los Angeles, New York and Dublin. Archelon, an options market maker with offices in Chicago and Frankfurt, explains that it was one of the earliest users of the Eurex derivatives exchange in Germany.
Getco, one of the largest liquidity providers, is more forthcoming in offering information about the firm and – for anyone thinking of applying for a job – offers a list of “recommended books on trading”.
It says that Getco works with exchanges and their regulators “to increase transparency throughout the industry and to create more efficient means for the transference of financial risk”.
Its philosophy includes “cultivating a low-ego environment, practising mental flexibility, frequently engaging in vigorous debate and treating everyone with respect”.
RGM Advisors even features photographs of its founders. It explains how the firm was started in 2001 by three men – one with a background in physics and another in “machine learning” – in one of their living rooms in Austin, Texas.
Many have a global presence – indeed they are sometimes dubbed “global” or “electronic” liquidity providers. Getco – or Global Electronic Trading Company – trades equities, derivatives, fixed income and commodities products on 30 markets around the world. In the US such firms account for 30-40 per cent of all equities trading volume, according to Rosenblatt Securities.
So no wonder the LSE is beating a path to their doors. These firms hold out the prospect of juicy revenues for European exchanges if they can persuade them to trade on their systems.
Europe’s exchanges need this new breed because traditional customers such as investment banks are capital-constrained, and because hedge funds are pulling back amid massive deleveraging.
They also face competition from new platforms – such as Chi-X, Turquoise and BATS – owing to the competitive forces unleashed by the Markets in Financial Instruments Directive, which broke the exchanges’ trading monopolies. Such platforms are geared towards the new marketmakers.
David Shrimpton, head of the LSE’s equity market development, says the exchange is now “highly engaged with these [marketmaking] guys”.
For the marketmaking firms, Europe is suddenly attractive too. They have been expanding offices in London to take advantage of the new opportunities that Mifid is creating. Getco is an investor in Chi-X and BATS, while Tradebot is a BATS shareholder.
For such firms, being able to trade on multiple platforms and arbitraging between price differentials on them is important to their trading strategies. So it helps that there are more trading venues emerging.
Dan Tierney, a co-founder of Getco and a former pit trader at the Chicago Board Options Exchange, says the firm is “very excited” by the progress being made in Europe “in terms of market structure, both in terms of the new entrants but also in terms of the moves the incumbent exchanges have made to make their processes more efficient”.
“We think the opportunity for more efficient risk transfer in Europe is tremendous and will benefit all investors in the long term,” he told the Financial Times.
Two months ago, the LSE introduced rebates aimed at such players. Unlike traditional users of exchanges who are charged a fee per trade, some marketmakers can be rewarded by posting liquidity on the exchange for others to match – thus generating activity.
“Traditional players will continue to play a crucial part, but the emergence of [the marketmakers] is a very interesting trend that’s coming to the European markets and we certainly want to make the most of it,” says Mr Shrimpton.
Euronext has also been wooing such firms. Cees Vermaas, an executive director, says: “We’ve been trying to attract these kind of firms out of the US and the biggest potential has been Chicago. It’s incredible what enthusiasm there is to come over to Europe.”
Unlike hedge funds, this type of liquidity provider does not have clients. They do not trade by taking a view on a particular stock.
Instead, they commit their own capital to make markets – as the Chicago pit traders did – by posting bids and offers on various exchanges.
By posting an offer on an exchange, they can be rewarded for making that commitment. They also use sophisticated technology and data analysis to trade in and out of a stock quickly, making money on the spread between the bid and offer and, they argue, making price discovery more efficient in the process.
Optimism over the potential that such firms seem to offer has not been damped by the downbeat outlook for equities markets next year.
Jelle Elzinga is global director of market structure at Optiver, a Dutch-based equivalent of such US firms. He says: “We have always said the liquidity providers are part of the entire market structure. They improve the quality of the prices on the exchanges by lowering the bid-ask spread.”
Nor does the extreme volatility of recent weeks seem to be an issue. Richard Gorelick, co-founder of RGM Advisors, a firm in Texas, says: “There really aren’t a lot of people out there willing to take risk right now. But we are willing to execute trades all day long and stand by them.” |
