NITE
From the street.com - MER/NITE deal just out - to be announced this week accordingly:
n the Clear: Merrill Sets Back-Office Deal With Knight/Trimark
By Dan Colarusso
Associate Editor
8/24/99 11:19 AM ET
In a union of tradition and transformation, Merrill Lynch (MER:NYSE) agreed to start handling
the back-office end of stock trades for Knight/Trimark (NITE:Nasdaq) in a deal that promises
to have larger implications for the brokerage firms.
After four weeks of discussions, three executives close to the deal say, Merrill's Broadcort
Capital unit will begin clearing trades in mid-October for the institutional brokerage and
market-making operations of Knight, one of the largest Nasdaq market makers and a
behind-the-scenes power in online trading and Internet stock traffic. Market makers ensure
that buy and sell orders from investors get completed, often taking the other side of trades
themselves.
The agreement, reached last week, is expected to be announced this week.
While brokerage-clearing agreements include record-keeping, trade confirmation and other
back-office tasks that involve about as much excitement as a Barbra Streisand movie, the
move by Merrill to bring Knight into its fold is a nod to the power of Wall Street's new
electronic elite. The two may at some point forge stronger relationships in international
operations and after-hours trading, the executives say.
"It's a clearing relationship first, with other strategic relationship potential," says one of the
executives close to the deal. The deal doesn't involve an ownership stake.
"Merrill clearly wants a piece of the burgeoning Net trading market," says independent
industry analyst Michael Flanagan. "What's becoming popular is for larger firms, such as
Merrill, to establish positions in businesses that may grow, many of which Knight is already
established in."
Goldman Sachs (GS:NYSE) is the most glowing example of this phenomenon. It has bought
stakes in online brokerage Wit Capital (WITC:Nasdaq) and electronic communications
network Archipelago. It formed a partnership with, among others, Merrill in electronic trading
system Primex and has agreed to acquire Hull Trading, an options firm with experience on
Europe's electronic markets, for $531 million.
So Merrill, suddenly, is in hot pursuit. It has rolled out an online trading option for its retail
clients, and the deal with Knight shows its desire to be a player in the trends that have driven
the market since late 1997. Knight is the primary market maker for the online brokerage
community, and the relationship gives Merrill, at the very least, a small slice of a business in
which it's not directly involved.
In addition, as Merrill rolls out its low-cost online trading product for retail investors, it also
could use Knight as a market maker in those trades.
For Knight, the deal represents an opportunity to bolster its international expansion. The firm
recently acquired an 18.9% stake in Easdaq, a European version of Nasdaq, and has
planned to expand its international operations by early 2000. If Knight can leverage the
clearing relationship further, Merrill's global institutional and retail client base could provide a
steady source of liquidity for the new project.
One Knight executive who asked to remain anonymous says the Merrill package even carries
the potential to help the firms with the infant after-hours trading, given Merrill's customer base
and Knight's market-making operations. A relationship with Merrill gives Knight potential
access to order flow from the firm, providing a buffer against any slowdown in the
online-trading world.
In June, Knight held a 17% market share in Nasdaq securities trading, according to the
AutEx Group, making it the largest market-making firm for those issues, and a 6.4% market
share in New York Stock Exchange-listed securities. Knight averaged 340,000 trades a day
during the second quarter.
For that kind of volume, Merrill was willing to charge bargain-basement prices. Two
executives close to the deal say Knight will pay less than $1 a trade, well below the industry
standard of $4 to $7 for this kind of business, and what it was paying with PaineWebber
(PWJ:NYSE), its clearing firm since March 1998.
Another possibility -- albeit a long shot -- for expansion of the relationship is electronic
options trading. Knight is one of the founding investors in the International Securities
Exchange, the first electronic options platform, and has already exercised its ownership
option into "seats" on the system. Stronger ties to Knight could result in Merrill sending order
flow to ISE, set to begin trading in the first quarter of 2000.
At this point, of course, all is conjecture. The firms are just now planning the switch and a big
move isn't likely to come too soon afterward. But on a Wall Street that finds itself in historic
flux, the firms will likely nurture any evident synergy. "Not many firms know where the industry
is headed," says Flanagan, the independent analyst. "They want to make sure they have a
piece of whatever direction it goes. They're covering all the potential bases."
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