Bats Said in Talks With Direct Edge Amid Four-Year Volume Slide
Bats Global Markets Inc. and Direct Edge Holdings LLC, formed to provide Wall Street firms with alternatives for trading, have seen their own options shrink.
The third- and fourth-largest equity exchange owners are in merger discussions, according to two people with direct knowledge of the talks. The discussions are progressing and may come to nothing, said the people, who asked not to be identified because the negotiations are private.
Formed with the help of some of the fastest traders on Wall Street, the closely held companies have watched as volume dried up in the U.S., cutting profits at the proprietary trading firms they cater to. Shares changing hands on all U.S. exchanges have fallen 36 percent since 2009 to 6.3 billion shares a day in 2013 and profits for high-frequency traders slipped 80 percent, according to data compiled by Bloomberg and Rosenblatt Securities Inc.
“Conceptually, this consolidation play makes sense, but the real question could be what happens after that,” Sang Lee, managing partner and co-founder of Boston-based Aite Group LLC, said by phone. “Assuming they have 10 percent each in market share and they are combined to get around 20 percent, then what? From a transaction business perspective you really haven’t acquired a new revenue source.”
Jim Gorman, a spokesman for Direct Edge, declined to comment, as did Suzanne O’Halloran at Bats.
Bats, an acronym for Better Alternative Trading System, started trading in 2006, aiming to match the incumbent exchanges on speed and beat them on prices. Seven years later, the firm’s daily average U.S. equity market share is about 10 percent, according to data from Tabb Group LLC. That compares to averages of 23 percent at NYSE Euronext and 18 percent at Nasdaq OMX Group Inc. Direct Edge has about 11 percent, Tabb said.
The discussions come as IntercontinentalExchange Inc. (ICE) prepares to complete the acquisition of NYSE Euronext, which owns the New York Stock Exchange, the oldest U.S. bourse. Combining Bats, based in Lenexa, Kansas, and Jersey City, New Jersey-based Direct Edge would make them the second-biggest market by volume.
Bats, which tried and failed to go public last year, was founded in 2005 by high-frequency trader Dave Cummings of Tradebot Systems Inc. and, along with Direct Edge, helped dismantle the duopoly on American stocks that was enjoyed by the New York Stock Exchange and the Nasdaq Stock Market.
“When Cummings set up Bats, it was really in response to the New York and Nasdaq having a dominant stranglehold on the equity trading market,” Larry Tabb, chief executive officer of the Tabb Group in New York, said in a phone interview. “But time moves on, order flows declined, it’s gotten much more competitive.”
This year’s acquisition of market-making firm Knight Capital Group Inc. by Getco LLC, the Chicago-based high-frequency trader, may have made a merger more likely, Tabb said. Both are shareholders in Bats. Knight, now KCG Holdings Inc., also owns a stake in Direct Edge.
Electronic platforms have seen their reputations dim over the last week after a connectivity issue caused Nasdaq to halt trading in all its listed shares for three hours yesterday and Goldman Sachs Group Inc. bombarded markets with mistaken options orders. Bats shut its main market for almost an hour on Aug. 6 when a computer system malfunctioned.
Bats, run with about 160 employees from a two-story office complex in a Kansas City suburb, operates two stock exchanges and an options market in the U.S. as well as Bats Chi-X Europe, the largest pan-European stock exchange.
William O’Brien, Direct Edge’s chief executive officer, said in September 2012 that he was focused on expanding as an independent company following a report in the Wall Street Journal his firm was in merger discussions with the owner of the Toronto exchange.
Speculation over a Direct Edge sale dates to December 2011, when the U.S. Justice Department made the divestiture of Deutsche Boerse AG’s 31.5 percent stake in the company, held through its International Securities Exchange unit, a condition of its proposed merger with NYSE Euronext. European regulators blocked the trans-Atlantic union two months later and the Frankfurt-based exchange never made a deal.
Both companies count trading firms and banks among their owners, and Bats gained two new shareholders this month. Private-equity firms Spectrum Equity Investors LP and TA Associates Management LP bought all of Lehman Brothers Holdings Inc.’s estate when it exited its investment, according to a statement from Bats and the investors.
Bats lists Getco as its largest owner with a 15.4 percent voting interest. Other owners include Morgan Stanley, Credit Suisse Group AG, Nomura Holdings Inc. and Citigroup Inc. KCG, Goldman Sachs Group Inc. and Citadel all have a 19.9 percent stake in Direct Edge. An additional 8.8 percent belongs to a group of five brokers, including New York-based JPMorgan Chase & Co.
“I think it makes sense,” Paul Gulberg, an analyst at Portales Partners LLC, said in a phone interview. “A combined company is probably more efficient to run.”
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