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November 1, 2004

UBS Assembles the Ultimate Machine: Schwab Purchase and Best Execution

By Gregory Bresiger & John A Byrne

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  • UBS Assembles the Ultimate Machine: Schwab Purchase and Best Execution

UBS AG, which surprised the trading world by buying Charles Schwab & Co.'s Capital Markets unit for $265 million, has greatly expanded its trading footprint. The benefits of the deal include an extraordinary ability to internalize more order flow.

The Swiss bank sees itself becoming a cost-effective trading competitor with rising profit margins. "This will propel UBS to a leading position as a top trader of Nasdaq securities globally and further our goal of becoming a premier provider of services to private clients around the world," according to John Costas, chairman and chief executive of UBS Investment Bank.

UBS, which runs a sprawling trading operation in Stamford, Conneticut, will meld the operations of the equities business and its investment bank. "By being the leading trader of equities, we will be able to drive marginal costs of executing trades," says a UBS spokesman. "We will be able to offer our clients natural liquidity across thousands of stocks."

Charles Schwab, founder of the San Francisco-based discounter, offered a practical explanation for the sale: There was no synergy between the capital markets unit and Schwab's main business. The sale concludes a series of efforts by Schwab to make a bigger impression in the institutional markets. It employed 123 trading pros in Capital Markets, comprising 66 market makers, 53 sales traders and four agency traders, Schwab told Traders Magazine for a survey in May. Then there were 100 other pros spread across the Jersey City-based unit. Some of the trading pros, including equities manager Larry Leibowitz, have been offered positions in the new operation. A spokeswoman said some Schwab traders and sales traders will stay with UBS, remaining in Jersey City until at least the middle of next year.

The trading operation was the domain of Lon Gorman, a vice chairman and president at Schwab Capital Markets. Gorman annou-nced his retirement soon after the deal was inked.

Several buyside traders, who were puzzled by Schwab's sale of the unit, commended UBS. "They are now going to be very strong in OTC trading," says one buysider. Another noted that UBS will now be able to bypass many exchanges and make more efficient trades in house. It is familiar territory. In the summer of 2000, UBS fattened its equity trading business when it picked up PaineWebber for $10.8 billion.

UBS, which was not a superpower in Nasdaq trading before the purchase, will now either be the number one or two Nasdaq trader, according to an AutEx/BlockDATA spokesman. UBS would now battle with the likes of Merrill Lynch and Morgan Stanley for the top place in listed trading and run neck and neck with Knight Trading Group in Nasdaq stock executions.

But the key factor in the Schwab purchase - in an era in which commissions are dropping in the trading industry - was order flow. That's according to an industry analyst who noted that Schwab will provide UBS with all its equity and options order flow for eight years. It includes retail and institutional business as well as order flow from Schwab's correspondent customers.

"They [UBS] are doing it for scale and Schwab's order flow will help them do it," says Rich Repetto, an industry analyst with Sandler O'Neill & Partners.