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February 1, 2013

Becoming a Superpower

GETCO's Looks to Knight's Wholesale and Retail Businesses as Keys to Growth

By Gregory Bresiger

GETCO, which began as a prop shop, intends to use Knight Capital Group's wholesaling connections along with large retail order flow to become a trading superpower. That, it hopes, will make it a trading power that will attract new institutional clients.

This is what trading executives told Traders Magazine about the electronic market maker's pending $1.4 billion deal to purchase liquidity giant Knight. Founded in 1995 and headquartered in Jersey City, Knight is also one of the largest market makers on the New York Stock Exchange-as is GETCO.

See Sidebar: GETCO At A Glance

Those relationships will help GETCO grow its business at a difficult time for equities, according to says Howard Tai, a senior analyst with Aite Group's capital markets practice.

Indeed, average daily volume in 2012 fell 17.6% to a level that is 33.9% lower than the peak of 9.8 billion shares a day in 2009, according to statistics compiled by Rosenblatt Securities. Knight makes markets and trades in some 19,000 U.S. equities, handling 3.0 billion shares a day, worth in excess of $20 billion.

Howard Tai, Aite Group

This large volume of trading should give GETCO great leverage in controlling its costs, several market participants said. But, more important will be connections with mutual funds and other institutional customers that come with owning Knight.

"The purchase will extend GETCO's wholesale distribution network," Tai said, pulling in large waves of orders from discount brokerages such as Ameritrade and ETrade, which serve retail customers.

GETCO must follow this acquisition path, several executives said, because the high-speed trading firm, originally established as the Global Electronic Trading Company, not only faces limits from lower volume, but in market making itself.

"Clearly, some of the electronic trading firms like GETCO are running out of new markets to go into with their current business model," according to Matthew Andresen, co-CEO of Headlands Technologies, a global quantitative proprietary trading firm in Chicago.

Firms who trade their own capital, even as high-speed market makers, reach a dead end when institutional investors pull back on buying and selling stocks.

"You're really relying on this institutional volume in the marketplace and if that volume has subsided, so too has electronic market making,'' said one brokerage executive. "Then you will have to go out and fight for a piece of that action. And it is very difficult to get a significant piece of that volume, if you don't have it sent to you directly."

Thus, GETCO to continue growing has to find a direct route to retail flow, said the broker, who declined to be quoted by name.

A Knight purchase "gets them the best distribution network in the industry," says Chris Nagy, president and founder of Omaha-based KOR Trading, a strategic advisory firm. Small broker-dealers, large online brokerages and banks all are "physically connected" to Knight, he says, and can send it orders, directly.