Hintz Sees Operational Risk Cost Rising Amid Knight Rout
Knight Capital Group Inc. (KCG)’s trading loss shows regulators may need to impose higher capital requirements on financial firms as so-called operational risk grows, said Brad Hintz, a Sanford C. Bernstein & Co. analyst.
“Things happen, and as I have more and more complex systems, with shorter and shorter time frames in terms of execution, we’re going to have mistakes,” Hintz said on Bloomberg Television’s “Surveillance” program with Tom Keene. “You’re going to have some questions in terms of operational capital charges.”
Operational risk, the threat posed by human or computer error, is eclipsing credit risk as the top concern at the U.S. Office of the Comptroller of the Currency, the agency’s chief, Thomas Curry, said in a May 16 speech. “Some of our most seasoned supervisors, people with 30 or more years of experience in some cases, tell me that this is the first time they have seen operational risk eclipse credit risk as a safety and soundness challenge,” said Curry, whose office doesn’t regulate broker-dealers like Knight.
Thomas Joyce, Knight’s chairman and chief executive officer, is “absolutely” a hero to succeed in lining up $400 million of new capital five days after a software malfunction spawned errant trades that caused $440 million of losses, Hintz said. Joyce understood that Jersey City, New Jersey-based Knight wouldn’t be viewed by regulators as “too big to fail” and would go bankrupt without new capital, Hintz said.
“It’s small enough that it could have” failed, Hintz said of Knight. “In a period of five days, he raised the capital so that he could open up this morning, because without the capital no one’s going to deal with the broker-dealer.”
Hintz compared Knight’s rescue to the 2008 takeover of Bear Stearns Cos., which was acquired on the brink of bankruptcy by JPMorgan Chase & Co. (JPM) Knight shareholders, like those at Bear Stearns, had almost all of their stock value wiped out, while creditors and counterparties weren’t harmed. One difference was that JPMorgan’s purchase was aided by the Federal Reserve Bank of New York, which didn’t play role in the Knight deal.
The broker-dealer agreed to sell $400 million of convertible securities to six investors to shore up its capital base, the company said today in a statement. The purchasers -- Getco LLC, the automated trading business backed by General Atlantic LLC, private-equity firm Blackstone Group LLP (BX), brokerages Stifel Nicolaus & Co. (SF) and TD Ameritrade Holding Co. (AMTD) and investment banks Jefferies Group Inc. (JEF) and Stephens Inc. -- will get preferred stock that can convert to about 267 million common shares at $1.50 a share.
Knight fell 24 percent to $3.09 at 2:28 p.m. in New York. The shares have plunged about 70 percent since the start of trading Aug. 1.
To contact the reporter on this story: Christine Harper in New York at email@example.com