Small Is Beautiful In Equities and Options

An independent direct market access (DMA) provider is achieving success, gaining ground in an industry becoming dominated by much larger players. In only 24 months, southern California's FutureTrade has landed 200 buyside clients as well as a coveted deal with one of the largest prime brokers. The firm's revenues have grown at double-digit rates every quarter. Most of its customers are hedge funds, a market in which FutureTrade has big expectations.

"There are 7,000 hedge funds out there," says FutureTrade's senior marketing exec Jim Kwiatkowski. "The potential is unlimited."

FutureTrade execs attribute their success to their approach to sales and support. They deliver DMA as a brokerage service, they note, rather than encumbering their customers with a complex technology. And the support they offer their clients is "highly configurable," they say, or suited to their needs.

Prime Brokers

Buyside traders use the FutureTrade platform to access both equities and options markets. As with most DMA technology, the system supplies traders with market data and the ability to take or offer liquidity without broker intervention. FutureTrade also has limited functionality to manage orders and the capability to integrate with the systems of prime brokers.

In equities, FutureTrade's reach extends to both Nasdaq and listed securities. Between 40 percent and 50 percent of the volume is in listed shares, most of it bound for New York Stock Exchange specialists via DOT.

While FutureTrade is ostensibly a technology vendor, it conducts all of its business through a brokerage subsidiary. Its customers access the FutureTrade platform over leased lines or the Internet, paying a per-share commission to the NASD-registered FutureTrade Securities. The average rate is about a penny per share. FutureTrade does not license its software.

Assets under management at FutureTrade's hedge fund customers start at about $200 million and climb into the billions, according to FutureTrade. Their trading is of the single stock variety but not lists. FutureTrade says list-trading capabilities are in development and are expected to be available by the end of this quarter.

Much of that development takes place in Russia's St. Petersburg and Estonia's Tallin. About 40 of FutureTrade's 50 developers are based in the two cities. The firm's total staff is now about 110.

FutureTrade's rapid growth has attracted experienced trading technology pros from various well-known organizations. The hiring spurt began in 2001 when Murray Finebaum was signed as president. Finebaum has spent 36 years in the industry, starting with lawyer stints at the Securities and Exchange Commission, the American Stock Exchange and Cantor Fitzgerald.

Finebaum became president of Instinet in the late 1980s and then ran a succession of electronic trading organizations including Globex (derivatives) and Trading Edge (fixed income). Finebaum has built an eight-man management team which includes such trading technology veterans as Lee Siegfried, formerly with Instinet; Kwiatkowski, of Bridge Trading and Reuters; Charles Susi, recently with SunGard Trading Systems; and Jim Haile, formerly CEO of options trading vendor Augend Technologies. FutureTrade bought Augend last year.

Finebaum himself was recruited by FutureTrade board members and institutional pros Ben Simon, a former hedge fund manager and sales exec with Montgomery Securities; Bobby Kahan, co-founder and head trader at Montgomery Securities; and Philip Stapleton, chief executive of Conifer Securities, a broker specializing in hedge funds.

All three pros are investors in FutureTrade, having taken control of the shop in 1999. The founders of FutureTrade, according to Finebaum, were two developers with strong technology skills, but little sense of the institutional business. They are no longer with the firm.

Following a period of beta testing, FutureTrade began its marketing push in early 2003 and quickly signed up 25 customers. By mid-year 2003, it claimed 50 clients. By the end of the first quarter of 2004, it was reporting 100 customers. By the fall, FutureTrade claimed 150 customers. At year's end, it boasted 200.

Financial Condition

FutureTrade's reported revenue growth is also impressive. Although the private company does not publicly release financial statements, it nevertheless says revenues doubled last year. For the fourth quarter, revenues grew 66 percent year-over-year, according to a statement.

Yet while the small shop clearly has traction, the world of institutional direct market access has changed considerably since FutureTrade was launched. In 2001, when Finebaum joined FutureTrade, DMA was a niche service. Providers were mostly small vendors and specialty brokerages. Only 14 percent of institutional orders flowed through DMA pipes, according to a recent study.

By 2004, the competitive landscape was changing dramatically. There were at least five acquisitions of DMA platforms by large brokerages last year, highlighting the mainstreaming of the service.

Banc of America, Citigroup, the Bank of New York, Investment Technology Group and Merrill Lynch all bought platforms. That put them in the same league as Goldman Sachs with its REDIPlus, Morgan Stanley with Passport, Instinet with Portal, and CSFB with Pathfinder.

Now just about every major full-service firm owns a DMA platform. The service is one of four now standard equity trading services offered by the bulge brackets. The others are block, portfolio and algorithmic trading. About one-third of the buyside's orders move through DMA pipes, according to TowerGroup.

For some observers, the DMA game is over. With most of the order flow in the hands of the top 20 broker dealers, small vendors and brokers will not be able to survive, they claim. "Bulge-bracket brokers have wrested control of the electronic trading market from independent vendors and second-tier brokers," according to Dushyant Shahrawat, a TowerGroup analyst. "Institutional brokers are the biggest and most influential players in the DMA space."

Shahrawat maintains the DMA market is saturated and a shake out is inevitable. Money managers will ditch their early providers for the full-service menu of the bulge bracket.

"What began in 2000 as an innovative service offered by just a few brokers," Shahrawat says, "has now become just another execution offering."

Commodity Business

That DMA has become ubiquitous is not news, of course. Specialty DMA broker Terra Nova Institutional (TNI), for instance, added research to its line-up in 2003 in an attempt to distinguish itself. TNI exec Jack Sholl has noted that direct access is now regarded as a commodity.

"By layering on a research component, Terra Nova adds a whole new value proposition," Sholl says. "And, of course, it's a higher margin business."

Nevertheless, some DMA providers see the glass as half full. The burst of acquisitions last year actually improved the picture for the independents still standing, they say. That's because there are hundreds of small and medium-sized brokerages that must still offer DMA to their buyside customers. They have to get it from somewhere and may not want to do business with the units of their larger rivals.

SunGard Trading Systems is one that sees an opportunity. The vendor is rolling out its Broker Direct U2 DMA platform to the sellside. Jim Leman, president of SunGard Trading Systems, is optimistic, saying U2 can be further pushed out to SunGard's brokerage clients' buyside customers. There is the chance brokers sponsoring Lava or other now-captive platforms may be mulling a switch.

An Assortment

And for them, FutureTrade is not the only independent out there. An assortment of small shops with sophisticated products are holding their own.

Some of the more popular have integration deals with Macgregor, one of the largest buyside order management vendors. Users of Macgregor can move data from their blotters to Edgetrade, Firefly/ITX, Neovest or UNX as well as those of the captives.

FutureTrade itself has already benefited from the takeover turmoil. The vendor landed Dallas-based agency brokerage CAPIS last year. CAPIS dropped Sonic Financial's DMA platform after that vendor was acquired by Bank of New York.

Other evidence, however, suggests the customer turnover may not be as high as hoped for. J.P. Morgan Securities offers the Lava platform to its institutional customers, but has no immediate plans to drop it.

"We are a member of their sponsoring broker program," says Emily Portney, chief operating officer for equities Americas at J.P. Morgan. "So, if a client likes it and chooses Lava, there's no point in not being on the list of one of the brokers they can pick. We're happy. We will continue with the program."

Portney's comments underscore an important reality of the DMA game. While brokers may not want to offer a certain vendor's platform, their clients may still insist. If the buyside trader wants Lava, he'll probably get Lava. In any event, it is not uncommon for a broker to sponsor more than one DMA platform.

FutureTrade is now benefiting from that reality. It recently launched its LiquidityPath service bureau for broker dealers. The service allows brokers' trading desks and prime brokerage departments to offer FutureTrade to their customers. FutureTrade has landed two big resellers.

Preferred Platform

Credit Suisse First Boston is now sponsoring FutureTrade to its buyside customers as its "preferred" DMA platform. The giant broker originally teamed up with FutureTrade last summer to make its algorithms accessible via the FutureTrade platform. In December, it went a step further, making FutureTrade available to CSFB's prime brokerage and options trading customers.

In January, FutureTrade signed Bear Stearns, one of the Street's top three prime brokerages. Bear will offer FutureTrade to both its hedge fund customers and its broker dealer clearing customers. The arrangement with Bear is non-exclusive, meaning Bear can sponsor other DMA platforms if it chooses. As with the CSFB deal, the arrangement with Bear calls for the partners to split any commissions received.

For FutureTrade president and CEO Finebaum, the two big deals validate the quality of his firm's offering. "The product was accepted by the buyside," he says. "Now the focus is on the brokers."