December 13, 2011, Dow Jones Newswires
A trio of Wall Street firms are gearing up to win orders from retail brokerages, targeting the type of "mom and pop" stock trades that have become increasingly valuable to sophisticated electronic traders.
Goldman Sachs Group Inc. (GS), Cantor Fitzgerald & Co. and Credit Suisse Group AG (CS, CSGN.VX) are launching new divisions that will collect individual stock orders from retail brokers and funnel them through the banks’ electronic trading systems.
Known as wholesale market-making, the business is dominated by a handful of firms that pay retail brokerages like TD Ameritrade Holding Corp. (AMTD) and Charles Schwab Corp. (SCHW) for the first crack at trading against individual investors’ buy and sell orders. Wholesalers reap profits by using automated trading strategies to quickly turn over the positions for small gains, and interpret the tone of incoming orders to inform trading decisions in other markets.
Goldman, Cantor and Credit Suisse will vie for the orders against Knight Capital Group Inc. (KCG); hedge-fund firm Citadel LLC; Citigroup Inc. (C); UBS AG (UBS, UBSN.VX); and E*Trade Capital Markets, a division of E*Trade Financial Corp. (ETFC)–the five firms with deeply entrenched wholesale businesses.
"People want alternatives," said Jarred Kessler, global head of equities for Cantor Fitzgerald, which aims to launch its offering in January.
Retail orders are attractive to automated traders and institutional investors because individuals invest with different aims than professionals who base their buying and selling on statistics and signals from other corners of the market, or those trying to carry out a much-larger trade.
In return, individuals are promised more competitive prices on their trades than they would get by dealing directly with exchanges, which charge fees to do business. Payments made by wholesalers to brokerage firms are also seen helping keep trading commissions low for customers.
The new entrants come to market amid a three-year decline in the overall level of stock trading. In 2009, an average 8.9 billion U.S.-listed shares traded each day, slipping to 8.5 billion last year after Greece’s debt problems worsened and the "flash crash" rattled markets in May 2010. Through November of this year, about 8 billion shares have traded on an average day.
Consultancy Tabb Group estimates that retail-level investors account for about 13% of all U.S. stock trading, or a little more than 1 billion shares each day.
As stock turnover slows, some of the order flow is being spread around more democratically. E*Trade earlier this year stepped away from its multiyear agreement with wholesaler Citadel and now directs some of its orders to rivals Citi, Knight and UBS as well as through its own market-making operations.
NYSE Euronext (NYX), the parent of the New York Stock Exchange, separately is pitching a new pricing program designed to make its markets a more attractive destination for individuals’ stock trades, and win back some business now scattered across 13 stock exchanges and dozens more private trading venues.
The newer wholesalers may also see an opening given potentially weaker competitors. Knight, UBS and Citigroup have announced restructurings and layoffs in recent months, while E*Trade was pushed by Citadel–one of its major stakeholders–to explore a potential sale after years of alleged underperformance. Citadel itself ended a bid this summer to build an investment bank, while keeping its market-making operations.
The new challengers have gained from the demise of another wholesaling firm, Bernard L. Madoff Investment Securities, which helped pioneer automated market making in the Nasdaq market in previous decades.
The operation, deemed the legitimate portion of the disgraced financier’s business, was sold to a firm called Surge Trading Inc. in 2009, but that effort didn’t take flight. Goldman Sachs hired Joe Valenza from now-defunct Surge Trading in April to work on the bank’s own effort, according to people familiar with the matter. Valenza had joined Surge in 2009 after a decade at Knight and other firms.
Credit Suisse last year hired Joshua Stampfli and Larry Birch, former executives for the Madoff market-making operation, to work on its offering.
Goldman has already signed up a small number of regional broker-dealers and online brokerage clients, a person familiar with the matter said. Wholesale market making gives the trading giant a way to expand its equity trading into a new area and take advantage of its investments in trading technology, which power Goldman’s market making in options and on the floor of the NYSE.
For Cantor, the wholesaling business is part of a broader push to build a global equity division. Kessler said a formal roll-out is planned for January and that using brand-new technology to power the effort will give Cantor an edge against established rivals with older infrastructure.
Cantor also aims to promote transparency, Kessler said, offering discount brokerages more detail on how trades are carried out and the superiority of the prices the firm can provide. "The more open we are with our clients, the more they’ll trust us," he said.
Wholesale market making is a long-standing practice on Wall Street but has drawn scrutiny as part of a broader debate among regulators and firms about the U.S. market structure, in which an increasing number of alternative trading sites and private trading venues has drawn significant share and volume away from NYSE and Nasdaq OMX Group Inc. (NDAQ).
Critics charge that "internalization," where firms match customer orders in-house first and route the leftovers to the exchanges after that, detracts from the publicly displayed quotes at the exchanges.