Nice Day For A “Bot Wedding…


Jeremy Grant of the FT published an article over the weekend (Two Proprietary Trading Firms To Merge) that details the merging of two large proprietary trading firms: Virtu Financial and Madison Tyler. We find the merger interesting for three reasons.

First, it was put together by Silver Lake Partners, a private equity firm with much expertise in the financial technology space. Silver Lake, if you remember, was a former shareholder in NASDAQ, and it also bought Instinet, our alma mater, from NASDAQ, and turned around and flipped it a year later to Nomura for a five-bagger. They sure do know deals. Previous deals also included Ameritrade, IDC, Island, Sunguard, and Mercury Payment Systems.

And it seems they understand the current market structure all too well. Mike Bingle, a Silver Lake executive, had this to say about the maturing HFT space: “This business is maturing; it’s an incredibly competitive market today. To be successful in all seasons you need to operate on a global basis and to have relationships with all the major market centers, as well as the regulators. It’s a big business today and it’s the type of thing that favors scale.” Hmm. They need relationships with all the regulators. Which is why the HFT firms hire hungry regulators away from the agencies. Is it an accident that the market structure has turned out the way it has, favoring predatory scalpers at the expense of investors and capital formation? Think about that.

Second, HFT margins have been diminishing, which is why it makes sense that they are starting to merge to get scale. And they have been pushing all of the Exchanges to give them more … stuff. Which is why the Exchanges’ margins have been diminishing. Which is why the Exchanges are also all scrambling to merge and get scale.

In this whole margin-eviscerating process, where the most important functions of brokerage firms (research, IPO’s, and aftermarket support (road-show and story-telling)) has been obliterated, it is nice to know that HFT and the Exchanges are each banging through asset classes globally, leveraging up to stay meaningfully profitable, increasing systemic risk in the process, and leaving behind their special brand of barren love in their wake. I’d say,“don’t worry, the Regulators will help you”, but according to Mr. Bingle, they are too busy cultivating relationships with the Exchanges and HFT firms.

Finally, we can’t help but be concerned that just as margins are getting bare, HFT firms are leveraging up, as are Exchanges, and relying on the same misguided short term models (on steroids though). Their partnership spurts out triple inverse ETF’s (Swaps) to “manage risk”, to stay afloat until the final regulations are in place that allow them to all churn highly leveraged opaque swaps.

It is sad, because we all see this happening, yet we watch in slow motion the train wreck that we know is coming.