As Citadel CEO Ken Griffin expands his business interests beyond hedge funds into one of the country's biggest trading venues, his efforts to shape regulation of the financial markets have increased as well.
Today, the Chicago firm's Citadel Securities trading unit claims to execute about 25% of stock and stock options orders for average investors, more than any other company. It's also a top market-maker in Treasury bonds and has carved out a foothold in swaps.
All that trading activity means more interests to protect, bringing Citadel out of its shell as it seeks a voice in the biggest government restructuring of financial markets in decades. From criticizing a proposal for a new stock exchange aimed at slowing down high-speed traders to crying foul on rivals' strategies, the privately held firm is speaking up to regulators and occasionally disagreeing with other market participants.
“They're a large company with a strong interest in market structure,” said James Angel, a Georgetown University professor who specializes in financial markets.
The passage of the Dodd-Frank Act in 2010 gave regulators the opportunity to reset market rules for the electronic age. As the Securities and Exchange Commission and Commodity Futures Trading Commission review changes, they're seeking input from market participants.
“Clearly, there's a lot that needs to be done that has not been done,” says Chris Nagy, a consultant at Kor Group in Omaha, Neb., who works with the nonprofit Healthy Markets Association.
Mr.
Griffin testified before the Senate Banking Committee last year on regulation of electronic trading. While recommending some changes, he said the U.S. equity markets are the “fairest, most transparent, resilient and competitive markets anywhere in the world.”
High-speed trading firms like Citadel, which buy and sell millions of stocks, futures and options every day, can feel big impacts on profits from even small legal changes.
While Citadel is mainly known for its 25-year-old hedge fund business, with $25 billion under management, its market-making operation took off after Mr. Griffin hired Jamil Nazarali in 2012 from rival Knight Capital Group, now KCG Holdings, to head execution services for Citadel Securities.
Asked recently about the firm's future, Mr. Griffin focused on the securities business first: “We're the largest market-maker in equities around the world,”
he told CNBC. “That's an incredible platform for us to build what will be, I believe, one of the great securities dealers of the next 25 years.”
Market-makers match buy and sell orders and then take a cut of the discrepancy between the two. They can match the orders at their own alternative trading systems, which are sometimes called dark pools, or send them to exchanges, where orders and prices are posted publicly.
FILLING VOID
With new Dodd-Frank regulations forcing the big Wall Street banks to step back from certain activities, firms like Citadel and other market-makers, including Chicago-based DRW and Jersey City, N.J.-based KCG, have new opportunities.
They're “angling to fill that void,” said Larry Tabb, who leads consulting firm Tabb Group. “I look at these organizations as really being the next Goldman Sachs and Morgan Stanley.”
Flexing its market-making muscle, Citadel is vociferously opposing a bid by IEX, the trading venue made famous by the Michael Lewis book “Flash Boys,” to become an exchange. IEX seeks to delay some high-speed price quotes in an effort to
level the playing field for traders who don't have the same computer speeds.
In two letters to the SEC in as many months, Citadel contends IEX will “harm market quality.”
Citadel also has complained repeatedly to regulators about competitors it says are breaking new rules barring “spoofing,” a form of market manipulation in which traders post bids they don't intend to execute. In two cases, the firm worked with regulators and prosecutors on enforcement actions against competitors. A trial in one of those cases in Chicago last month resulted in the first criminal conviction of a spoofer.
Mr. Nazarali this year joined an SEC advisory committee, and Citadel has advocated some equity market changes, such as exchange kill switches to stop major market errors and changing the rules governing the duties of self-regulatory organizations in the markets.
“Our clients want us to be their advocates and they want us to play a leadership role in helping to discuss market structure,” he said.
So far, Citadel Securities has succeeded in heading off efforts to limit its ability to pay retail market-makers such as Schwab for order flow, despite criticisms that such payments create conflicts of interest.
The debate isn't over, though. Sitting next to Mr. Griffin at the Senate hearing last year was Jeff Sprecher, CEO of Atlanta-based Intercontinental Exchange, which operates the New York Stock Exchange and the ICE futures market. He continues to decry payment for order flow and the proliferation of competing trading venues such as Citadel's that have whittled his stock exchange's market share to 24%.
Lynne Marek is a senior reporter at sister publication Crain's Chicago Business
