no_thanks

My understanding under the current interpretation of the Volcker rule is that pure market making is still allowed. I have not heard anyone in the industry mention or imply that the banks will be under any pressure to spin off their market making arms like they were forced to do with their prop and hedge fund arms. Thanks, really appreciate it. How did you get into the industry? Math or CS background?

The lack of moat for market makers is partially because it is a secondary business for most of their competitors which provides benefits for their primary business and is not forced to stand alone. In the case of the large investment banks (Citi, Morgan Stanley, Goldman, BAC, etc.), there are multiple benefits: 1. For firms that they have a prime broker relationship with (hedge funds, buy side, prop, etc) they will often stipulate that as part of their prime brokerage agreement the firm is obligated to send their firm through the investment banks infrastructure / market maker and if they chose to route to a different firm they will have to pay additional fees. 2. All of these firms have a substantial amount of "captive" order flow that originates from their retail broker and wealth management arms. Their market maker division gets exclusive rights to this. 3. They view it as a service they are expected to offer as part of an overall relationship with large customers. Not having this capability could be viewed as a negative when pitching large potential clients. The second set of firms that often end up with market making firms are HFT/Prop firms (Wolverine, Two Sigma, Getco before Knight merger). In this case, these firms are already active on the major exchanges running their own HFT algos and trading their own accounts. At some point, they realize that by virtue of being a successful HFT they have created the vast majority of the infrastructure required to be a market maker for client flow and since the majority of the infrastructure can be shared any additional revenue they generate from attracting client order flow will offset the increasingly large costs of maintaining an up to date infrastructure. Furthermore, the idea of having some diversification from prop trading which is heavily dependent on volatility and volumes is extremely attractive. The interesting thing is that most firms don't move in this direction until their HFT profits have peaked because retail market making is far, far less profitable than successful prop trading. The final problem these firms face is that all of their clients have relationships and connections with multiple of their competitors so in the case where a firm does get into trouble, their clients completely abandon them w/in hours. This is what happened with Knight during their blowup. In the couple days between the event and the announcement of the new investor buy-in, the majority of their clients had ceased to send _any_ orders to them. Why would they take even a modicum of risk when they can receive the exact same product at multiple other firms who did not have that same level of risk? Thanks a lot for the explanation. Really great insight. I will keep it in mind. Sorry I am a little uninformed, but isn't the Volcker rule going to force the big banks out of this business?

I also work in the industry and agree with constructive. The market maker space is incredibly competitive and provides no sustainable moats. There are often price wars when new entrants enter the market which drives down returns for all participants. Thanks for the feedback. So you don't think that the technological infrastructure, know-how, and regulatory system will keep others from taking market share from Knight? It seems like others would see the trading glitch as a good reason to stay away as it is an easy business to shoot yourself in the foot in. Since there are some people in the industry here, are GETCO and Knight going to offer a better product than the other market makers? Why are competitors trading at over 3x TBV while KCG is just a little over 1x TBV?

I actually am kinda attracted to these situations because I believe a lot of time people are giving to much weight to recent issues. Yes, it may happen again, but does that risk justify the discount it trades at to it's peers? And the company, if they are sane, is liking devoting a ton of resources to making sure that the same problem doesn't happen again, so in my opinion it is less risky that it was before the initial incident, but that is in hindsight of course. Welcome any more feedback though.

I bought some a few days ago. Would love to see any research if you come across it. Do you see the banks moving away from market making, and that helping KCG? Thanks.

Wow, I bet that has been a wild 17 yrs. I would love to hear more.