Market-Maker Virtu Expands Globally as It Mulls Public OfferingNina Mehta and Inyoung Hwang
Virtu Financial LLC, the electronic market maker that tried and failed to buy Knight Capital Group Inc. in December, may consider an initial public offering and acquisitions as it expands, according to President Doug Cifu.
Virtu, which Cifu says accounts for more than 5 percent of U.S. equities volume, plans to add products and enter new markets as the firm diversifies its trading. It earned about $240 million before interest, taxes and other expenses last year, according to a person familiar with the matter who declined to be named because the information is private. Cifu said an IPO could make sense under certain conditions and that acquisitions may accelerate expansion into new businesses.
The company, which traded only stocks listed in the U.S. when it started five years ago, now handles shares on six continents, along with government bonds, foreign currencies, contracts in energy and metals, and futures. Its profile rose last year when it bid for Knight and again last month after Chris Concannon, a partner at the New York-based firm, met with new Securities and Exchange Commission Chairman Mary Jo White about overseeing the agency’s trading and markets division.
The firm would consider an IPO “at the right time and in the right market,” Cifu said in an interview at Virtu’s Manhattan office. While the firm continues to build its market making, “the allure of M&A is that with a wave of the pen we can get into a business and scale quickly,” he said.
Virtu is boosting its trading even as some rivals struggle. Getco LLC, which won the Knight bidding war, saw profit fall 90 percent to $16.2 million last year, according to an April 15 regulatory filing by Knight. Interactive Brokers Group Inc. is committing less capital to its market-making unit and may get out of the business if profitability doesn’t improve, Chairman and Chief Executive Officer Thomas Peterffy said on a conference call on April 16.
Trading firms have seen key sources of profits get squeezed as U.S. equities volume has fallen three years in a row and volatility, as measured by the Chicago Board Options Exchange Volatility Index, or VIX, reached a six-year low in March. Electronic market making, in which firms earn money by buying at the bid price and selling at the offer, depends on scale and technology to eke out tiny profits as the bid-ask spread across assets have shrunk over the last decade.
Virtu, which provides bids and offers on 205 venues around the world in products from U.S. equities to silver and copper futures, says its fastest growth is currently in currency trading and providing liquidity to stocks in Asian markets including Japan and Australia. It expects rapid growth in new products that will become available when over-the-counter derivatives start trading electronically under rules mandated by the Dodd-Frank Act, Cifu and Concannon said.
“Dodd-Frank is the biggest IPO the financial markets have ever seen,” Concannon said, referring to the 2010 legislation passed by Congress that mandated changes to the financial sector, including a requirement to process most swaps through a clearinghouse to cut counterparty risk. “You can’t find a better time to be in the market as an electronic market maker.”
The rules, part of an effort by regulators around the world to overhaul the $639 trillion derivatives market of privately negotiated swaps, will boost price competition for derivatives and new futures, Concannon said. Virtu expects to buy and sell interest-rate swaps and other products electronically on exchanges and so-called swap execution facilities, he said.
Such regulations can benefit trading firms including Virtu because they establish rules everyone must follow and provide an entry to markets that previously were opaque and dominated by banks, Sang Lee, managing partner at Boston-based research firm Aite Group LLC, said in a phone interview. It also enables them to diversify their businesses, he said.
“It seems counterintuitive to some people, but it’s actually true they like regulation, as long as it’s not regulation that says, ‘You can’t trade in microseconds,’” Lee said. “As long as it’s a set of rules that puts a framework around these markets, it’s good for them.”
Bloomberg LP, the parent of Bloomberg News, sued the Commodity Futures Trading Commission last month, arguing that rules setting higher collateral standards for swaps than comparable futures are arbitrary.
High-frequency trading continues to draw criticism and run the risk of attracting regulation that could limit business by firms such as Virtu. Hundreds of academic papers have been written and regulatory studies done seeking to gauge its impact on trading, price discovery and competition for orders. High-frequency trading relies on the automated and rapid placement of orders, many of which are immediately canceled or updated, and encompasses strategies such as market making, statistical arbitrage and momentum-based tactics.
Fighting the image of high-speed participants as firms that exacerbate volatility and trade only when it’s in their interest has been like pushing a rock up a hill, Cifu said. Virtu acquires positions by posting bids and offers and not by taking liquidity supplied by others, he said. It trades against bids and offers solely to manage risk.
“We don’t try to convince the world that high-frequency trading is good,” Concannon said. “We simply explain that we’re a registered market maker with obligations around the world.”
Virtu also commits to providing liquidity for a certain number of shares or contracts and at certain bid-offer widths in broker-run dark pools and private venues quoting foreign currencies, Concannon said. The market maker offers quotes in about 30 U.S. dark pools, he said.
Concannon and Cifu run the firm’s daily operations with Vincent Viola, Virtu’s controlling shareholder, chairman and chief executive officer. Viola, who was chairman of the New York Mercantile Exchange from 2001 to 2004, cofounded the company in 2008 with Cifu and Graham Free, its global head trader. Cifu, who is also chief operating officer, previously was a partner and co-head of the private-equity group at law firm Paul, Weiss, Rifkind, Wharton & Garrison LLP.
Concannon, a former executive vice president at exchange operator Nasdaq OMX Group Inc., met with the SEC’s new chairman about running the agency’s division that regulates exchanges and sets policies for markets on April 10, White’s first day on the job, according to people briefed on the discussions who spoke on condition of anonymity because the meeting was private.
The lawyer and former exchange executive said he plans to stay at Virtu. He worked at the SEC in the mid-1990s and later held several positions at Island ECN and Instinet Group Inc. before joining Nasdaq Stock Market in 2003 when it bought a business owned by Instinet.
Private-equity firm Silver Lake Partners LLC invested in Virtu in 2011 in connection with the market maker’s acquisition of Madison Tyler Holdings LLC, which Viola and David Salomon, a former arbitrage trader at Goldman Sachs Group Inc., cofounded in 2002. Virtu is profitable every day, according to Cifu.
“As a market-making firm that does not take a directional view of the market, we historically have not had trading days where we lose money across the firm,” he said.
Virtu lost its all-cash bid for Knight to Getco’s offer of cash and stock. Chicago-based Getco, one of six firms that rescued Knight from the brink of bankruptcy with a $400 cash infusion in August, planned to retain the firm’s public listing while Virtu intended to take it private and go public later, a person familiar with the matter said in December.
An automated market-maker going public now would have to prove it has a “sustainable competitive advantage” over rivals in a business anyone can enter, James Angel, a professor of finance at Georgetown University in Washington, said by phone.
“The basic strategy is well known: buy at the bid and sell at the offer,” Angel said. “When a bunch of other people figured out they could do the same thing, the result was intense competition. From a corporate-strategy perspective, the electronic market-making business is hell on earth.”
Virtu, which often accounts for more than 10 percent of average daily volume in Microsoft Corp., usually makes less than $1,000 a day trading its shares, underscoring the shrinkage in bid-offer spreads and importance of managing its risk at every moment, Cifu said. The company has millions of dollars in positions across asset classes globally at any point in time and can lose thousands of dollars in a millisecond, he said.
Cifu declined to say how much Virtu spends annually on risk management, technology and colocation services, in which its computers are placed near the trading engines of exchanges or other venues. Virtu has 130 employees and hires mainly individuals with advanced degrees in computer science and programming, math, chemistry and physics.
Getco spent $84.1 million last year on data lines and colocation, more than four times as much as in 2008, according to Knight’s April 15 filing.
Virtu has made deals in recent years to broaden its reach. It bought a market-making unit that handles NYSE MKT stocks from Cohen Capital Group LLC in December 2011 and became the largest overseer of trading in shares listed on that exchange, owned by NYSE Euronext. It acquired Nyenburgh Holding BV, an Amsterdam-based firm that makes markets in exchange-traded funds, last September.
The Cohen business allowed Virtu to learn how to supply liquidity in less-active stocks while the Amsterdam firm expanded its scope to European ETFs, Concannon said. Virtu expects to broaden its trading beyond the roughly 2,000 U.S. companies it now handles as a market maker, he said.
Virtu trades through regional offices, with its Singapore office handling Australia and Asia, while the Middle East and Europe are managed from Dublin. Employees in New York and Santa Monica, California, are responsible for trading in North and South America, energy products and currencies.
“We see further growth around the world,” Concannon said. “There are still products around the globe we don’t trade and touch and would like to trade and touch.”