* KCG reported Q4 a loss of 15 cents a share
* Call to end rebates for market makers won't gain
* Firm expects $41 mln on closing of BATS/Direct Edge merger
By John McCrank
NEW YORK, Jan 31 Trading firm KCG Holdings Inc
, which reported a quarterly loss on Friday due to merger
costs, plans to trade interest rate swaps before the year is
out, the company's chief executive said.
Interest rate swaps, which allow investors to hedge against
interest risk, make up $490 trillion, in notional value, of the
$633 trillion over-the-counter derivatives market. Much of the
swaps market is moving onto new exchanges known as swap
execution facilities (SEFs), as required by the Dodd-Frank
financial reform bill, representing an opportunity for trading
firms like KCG.
The move to SEFs will bring more electronic trading, as
opposed to brokers trading between themselves over the phone, to
the over-the-counter derivatives market, and is aimed at
"I do believe that transparency in swap trading will be
beneficial to all market participants who trade interest rate
products," KCG chief executive Daniel Coleman said on a call
with analysts. "It's something that we would like to do and
something we are focused on."
Under the new rules, swaps must also be centrally cleared,
meaning clearing houses back the trades against a default,
opening up the market to firms that do not need massive balance
sheets to stand behind the trades.
The OTC derivatives market came under regulatory pressure in
the wake of the financial crisis when risky trading at firms
such as insurer American International Group Inc and
investment bank Lehman Brothers nearly toppled the financial
system. The inability to assess the scale of the market, the
identity of contracting parties, or the nature of non-standard
contracts, frustrated regulators.
More recently, there have been growing calls for an overhaul
of U.S. equity market regulation in order to reduce conflicts
and complexities in the system.
One of the loudest voices as of late has been Jeff Sprecher,
who heads IntercontinentalExchange Group, the new owner
of the New York Stock Exchange. Sprecher has called for an end
to the dominant pricing system in U.S. equities, in which market
makers receive trading rebates for posting orders to exchanges
for other market participants to trade against.
As one of the top U.S. equity market makers, KCG made around
$48 million in profit on just under $233 million in
market-making revenues in the last quarter.
Overall, the firm, which also operates dark pools and
provides trading services in multiple asset classes and
countries, reported a net loss of $17.4 million, or 15 cents a
share, on $322 million in revenues. The loss included $36.5
million in merger and integration costs.
The pricing system, known as "maker-taker," in which the
"maker" of the liquidity on the exchange receives a rebate and
the "taker" - the buyer of the stock - pays a fee, is "bad for
markets," Sprecher told Reuters last week.
He said the system attracts people who quickly jump in an
out of markets looking to profit from rebates, rather than
actually trade or hold risk. He said the rebates distort stock
prices and cause the interests of brokers to be out of sync with
Coleman said that ultimately maker-taker is the way
exchanges compete with each other, and that if rebates are
removed, exchanges would still compete on taker fees and brokers
would still face the conflict of routing one exchange versus
another based on fees.
"You have the head of a commercial enterprise saying he
doesn't want to compete on fees any more ... so from that point
of view, I don't think that argument is going to gain a lot of
traction," he said.
KCG said that at the end of the quarter it received around
$10.5 million from Nasdaq OMX Group as part of the
exchange operator's compensation plan for the botched Facebook
IPO in May 2012. During the IPO, a glitch in Nasdaq's system
prevented timely order confirmations for market makers, leaving
them unsure about their exposure for up to days afterwards.
Knight Capital Group, which merged with rival firm Getco
last summer to create KCG, recorded a charge of $35.4 million in
the second quarter of 2012 related to the Facebook IPO.
Knight had its own glitch in August 2012, which led to
millions of unintentional orders flooding into the market over a
45-minute period, leaving the firm with a huge position it had
to unload at a total loss of $461.1 million. KCG agreed in
October to pay a fine of $12 million over the incident.
Separately, KCG said it expects to receive $41 million as
part of a dividend payment once exchange operators BATS Global
Markets and Direct Edge close their merger, which is expected to
happen within days. The deal cleared its final regulatory
hurdles on Friday. KCG owns stakes in both BATS and Direct Edge.