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July 15, 2007

ITG Finds 1-Percent Solution

Electronic Broker Looks for Savings Through Self-Clearing

By Gregory Bresiger

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Self-clearing will provide lower trading costs for a big publicly traded agency broker and boost its bottom line. This is what officials of Investment Technology Group (ITG) said as the firm recently implemented a program of self-clearing. ITG will no longer use Jefferies & Co.'s clearing platform.

The move represents a total break with the firm that had spawned ITG and its flagship product, the matching engine Posit, roughly 20 years ago.

Jefferies eventually spun out ITG. Nevertheless, the two firms continued a close business relationship for years, which included clearing. In fact, Jefferies employees were among the largest block of shareholders when ITG went public.

Although ITG officials wouldn't comment on the record, they have previously told analysts that there are big savings in self-clearing. Indeed, in a conference call with analysts in May reviewing the recent financials, ITG officials announced that self-clearing savings were on the way.

A Clearing Move

Commencing in this quarter, and in this month, we're moving to self-clearing so we're going to start to see some [cost savings] on the clearing side," according to Howard Naphtali, ITG's chief financial officer. He was answering an analyst's question.

ITG officials estimated that if they had been self-clearing last year, they could have saved about $3 million in transaction costs. And that would have improved the firm's profit margins by almost 1 percent, they say.

With increased trading volumes this year, they expect annual savings will be about $3.5 million. ITG s net income rose in the 2006 calendar year by 38 percent to $91 million on revenues of $586 million.

Analysts and brokerage officials gave several reasons for a brokerage firm to move to self-clearing. For instance, some believe that self-clearing allows a firm to have more control over how trades are executed. Others say self-clearing leads to economies of scale that come with huge numbers of trades.

ITG describes itself as an agency broker whose "primary goal is to minimize the market impact of institutional trades by matching them in block size."

But it also has a sizeable algorithmic trading suite of products that helped it grow. And these products have also given it the ability to realize savings in a switch to self-clearing.

Trading has been good for ITG's brokerage and its Posit crossing network. ITG's average daily U.S. trading volume in the first quarter was 191 million, which was 16 percent better than the previous quarter and 41 percent better than a year ago. It was the same growth story at Posit. Average daily trade volume in this anonymous institutional crossing space was 61.1 million shares in the first quarter. That compared with 46.9 million shares in the previous quarter.


ITG also has been expanding its multi-asset trading capabilities. For example, it recently bought RedSky Financial, a Chicago-based broker-dealer that specializes in electronic multi-asset class trading. RedSky's R3 trading platform is known for exchange-traded and fixed-income trading. Despite building its reputation as a cash equities broker, ITG recently expanded its execution platforms-Triton and Radical-to focus on equity options and futures. All this growth means it may be more cost-effective now for ITG to self-clear, some industry observers suggested.

But how, specifically, do these economies of scale work?

Matt Bienfang, a trading industry analyst with TowerGroup, says there is no magical number of trades that makes self-clearing more efficient than clearing through third parties.