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Goldman Sachs, Getco, Morgan Stanley Buy Stakes in Chi-X Global

Tuesday, October 18, 2011

BLOOMBERG NEWS

By Nina Mehta

Oct. 18 (Bloomberg) -- Goldman Sachs Group Inc., Getco LLC, Morgan Stanley and two other firms bought equal stakes in Chi-X Global Holdings LLC, the operator of equity markets in Canada and Japan owned by Instinet Inc.

Bank of America Corp. and Quantlab Group LP also made investments, according to a statement issued by Instinet. No prices were disclosed. New York-based Instinet, a unit of Nomura Holdings Inc. in Tokyo, maintains control of the Chi-X, Tal Cohen, its chief executive officer, said in a phone interview.

Brokers have become owners of exchanges and alternative trading venues to get more say in how the markets are run and ensure they remain competitive with bigger rivals. Exchanges are seeking combinations to build scale and process more transactions on a single trading technology infrastructure.

“Having major order-flow providers as equity partners gives trading venues an important competitive edge,” Justin Schack, managing director for market structure analysis at New York-based Rosenblatt Securities Inc., wrote in an e-mail. “Firms that own part of an exchange or alternative market have an incentive to favor that venue, within the bounds of best- execution obligations and regulations.”

In return, brokers get more influence over pricing, the rules that define the market and new products, Schack said. They also get the “opportunity to realize capital gains should the venue go public or be sold,” he said.

Proprietary Trading

Getco in Chicago and Houston-based Quantlab are proprietary trading firms that buy and sell stocks and financial products with their own money. Bank of America in Charlotte, North Carolina, and New York-based Goldman Sachs and Morgan Stanley are among the biggest banks trading U.S. equities.

Chi-X Japan accounted for 2.7 percent of the Nikkei 225 Stock Average by value traded in September, according to the company. Chi-X Canada had 10 percent of Canadian equities in the third quarter, data from the Investment Industry Regulatory Organization of Canada shows.

Financial Technology Partners LP and FTP Securities LLC advised Instinet and Chi-X Global on the transaction.

Chi-X Global is considering an equity participation program that could give its owners varying stakes in the company based on their supply of orders to its markets, Cohen said. The five brokers made equal capital investments in Chi-X Global and no program offering incentives is currently in place, he said.

“We will look at different strategies to broaden ownership,” Cohen said. “We’ll definitely consider a strategy where we provide ownership stakes for participation. That’s separate from the deal.”

European System

Such a plan could work similarly to one by Chi-X Europe Ltd., which is separate from Chi-X Global, Cohen said. The European market is owned by Instinet and more than a dozen brokers including Getco, Morgan Stanley, Goldman Sachs and Bank of America. That venue runs Europe’s largest alternative trading system and agreed in February to be bought by Bats Global Markets Inc. in Lenexa, Kansas. The deal is expected to close in the first quarter.

“Chi-X Europe is a good example,” Cohen said. “There was an initial capital investment and then over time firms increased their stakes or more firms came on board through those types of programs. It helped build the market and has proven to be successful.”

Global Mergers

Deutsche Boerse AG in Frankfurt said in February it would acquire NYSE Euronext, operator of the New York Stock Exchange, for $9.53 billion. The value of that agreement has plummeted by 26 percent. Sydney-based ASX Ltd.’s merger agreement with Singapore Exchange Ltd. and London Stock Exchange Group Plc’s combination with TMX Group Inc. in Toronto fell through as shareholders balked or regulators nixed the cross-border deals.

The New York Stock Exchange and other markets used to be membership-based entities owned by the brokerage firms that traded there. NYSE went public in 2006 by purchasing Chicago- based Archipelago Holdings Inc. Nasdaq Stock Market acquired electronic rivals and later the Philadelphia and Boston exchanges. As exchanges converted members into shareholders and regulators changed trading rules, brokers began to form competing markets or take stakes in them to reduce the fees they pay for executions and make sure their needs are met.

Bats Global Markets, Chi-X Europe and Jersey City, New Jersey-based Direct Edge Holdings LLC, which operates two U.S. stock markets, have sold stakes to groups of brokers that could send them orders. Bats is owned in part by Bank of America, Tradebot Systems Inc. and Getco. Direct Edge is owned by the International Securities Exchange, Goldman Sachs, Citadel LLC and Knight Capital Group Inc.

Overseas Ambitions

Chi-X Global plans to extend its holdings internationally with the help of new owners.

“We want to expand into markets principally in Asia and Latin America and bring regulatory reform and technological competition to the benefit of issuers and investors,” Cohen said. While individual markets haven’t yet been discussed, the brokerage investors in Chi-X Global “see the opportunity to open up markets,” he said.

Chi-X Global is already expanding its businesses. It’s preparing to introduce Chi-X Australia, a market designed to compete with Sydney-based ASX’s Australian stock exchange on Oct. 31. The company also operates Chi-East, a joint venture with the Singapore Exchange that runs a dark pool for Japanese, Hong Kong and Singapore securities. Dark pools are private venues that don’t display prices in advance. Australian securities will be added to the platform in the coming months.

A system called Chi-FX will start in Brazil early next year. That market will provide quotes in domestic equities in different currencies and is a venture with Sao Paulo-based BM&FBovespa SA, Cohen said.

Sang Lee, managing partner at Boston-based Aite Group LLC, said in a phone interview that selling stakes to brokers has been successful in drawing volume to new venues.

“Brokers invest in many types of ventures,” Lee said of the Chi-X Global deal. “They’ll hedge their bets. But if this succeeds, they’ll certainly have a strong say in determining how the market structure changes happen and how they benefit from that.”

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