HFT: Not so flashy anymore

After a string of M&A deals in the HFT space at the beginning of the year, does it spell an end to the traditional HFT business model? Writes Joe Parsons.

By Joe Parsons June 14, 2017 10:50 AM GMT

After the publication of Michael Lewis’s “Flash Boys” in 2014, the high-frequency trading (HFT) firms dominating financial markets in the shadows were brought to light.

They were pictured as predators, using high powered computers to execute trades at a millionth of a second, putting other market participants at their mercy.

Fast forward a few years later and the big bad HFT monsters don’t look quite so flash or scary. With the volatility index (VIX), also known as the ‘fear gauge’, at an all-time low, HFT firms are now facing a challenge they never thought they would have to face: making money.

It has forced some of the big players to make some radical decisions, with consolidation taking hold. The shock announcement that Virtu Financial will take over KCG in a massive $1.4 billion deal (which stole the show at this year’s FIA Boca conference in March) was the first major acquisition to arise out of 2017.

The decision from KCG to merge with its long-time rival could have been motivated out of declining profits. KCG had struggled outside of its US equities business in 2016, as revenues for non-US market making in the fourth quarter plummeted 60% to just $17 million in comparison to $43 million in the first quarter. 

This was followed up with news Houston-based Quantlab Financial would buy a high-speed trading business from Teza Technologies for between $20-30 million.

Finally Two Sigma Securities, the market making arm of Chicago based quantitative hedge fund Two Sigma, will purchase the options trading business of Interactive Brokers.

Tumber Hill, Interactive Brokers options market making unit, said it would shut down after 25 years of operation, following a reported $22 million loss in market making in the first quarter of 2017.  The wind down of the unit is expected to cost the company an estimated one-time cost of $25 million.

Fast but not so furious

So why has consolidation become the order of the day? Alongside a decline in profits, one motivation to merge is to expand into new asset classes.

“The acquisition of KCG shows the continuing competitive spot that marketplace is in. It has become more competitive for the HFT industry in general, and I wouldn’t be surprised to see more consolidation in that space. You will see some of the true proprietary traders merge as an expense cutting play and as a way to move into new asset classes,” says Carl Gilmore, president, Integritas Financial Consulting.