See related sidebar: NYSE's Makeover Attracted GETCO to Designated Market Maker Role
When NYSE Euronext announced in February that GETCO, one of the biggest players in high-frequency trading, would become a designated market maker, or DMM, on the New York Stock Exchange floor, the news immediately became a hot topic among both the buy- and sell-side communities. As a DMM (the revised term for an NYSE specialist), GETCO posts bids and offers in 350 NYSE stocks. The firm, which officially assumed the role in April, rolled out about half of the symbols within the first two weeks.
As a major proprietary trading firm, GETCO has commanded a certain mystique. Now, however, the closely guarded firm known for its electronic market making has decided to play an important, very public role at a brand-name exchange. But given the controversy swirling around high-frequency trading and the intense SEC scrutiny the trading style has received in the past year, the news about GETCO's new DMM status has raised concerns among buy-side traders.
"We've always viewed ourselves as a market maker, and this DMM opportunity is another extension of our core business," explains Dave Babulak, managing director of GETCO. "That's the core of our business. The vast majority of our orders are passive liquidity."
Change Is Coming
Why did GETCO, a global electronic market maker in all asset classes -- including equities, fixed income, futures and commodities in the Americas, Europe and Asia -- decide to become a DMM with a floor presence? "These opportunities are rare," says Babulak, who explains that the firm bought a chunk of the former specialist LaBranche's business from Barclays. "This is an opportunity to make markets in a different market structure."
With 22 percent market share, the NYSE constitutes the biggest pool of liquidity in NYSE-listed stocks and one with which a computer-driven trading firm such as GETCO wants to interact. GETCO already was an electronic market maker in U.S. equities on BATS, Nasdaq and NYSE Arca, as well as a supplemental liquidity provider, or SLP, in 500 NYSE stocks. Some market participants argue stepping up to the DMM role was the logical next step.
"It's a high-profile role," says Joseph Mecane, EVP and chief administrative officer for U.S. markets at NYSE. From the exchange's perspective, "GETCO is our largest SLP -- they had experience with our marketplace, and the DMM evolution is just really the next step in growing with the NYSE model," he explains.
"GETCO is obviously a large participant in the marketplace," Mecane adds. "As they look at additional ways to get involved in the marketplace, our model is an attractive model for them."
The liquidity GETCO supplies to the market is a positive for issuers and the NYSE, Mecane continues. "They have insight into stocks," he insists. "We think they'll be able to make tight markets on their platform, which is good for investors."
About a year ago, the NYSE revised its market model to add value to the specialist role and introduced the new DMM designation. Meanwhile, a year earlier, the exchange had created the SLP role. At the same time, the NYSE revamped its technology and rule set to be more friendly to high-frequency trading firms. Sources credit the new market model, including the start of the SLP program and the introduction of the DMMs, with helping the NYSE stabilize its market share in the wake of the fragmentation of listed volume across multiple trading venues that stemmed from the introduction of Reg NMS. GETCO currently is one of only five firms -- along with Goldman Sachs, Kellogg Group., Bank of America and Barclays Capital -- serving as NYSE DMMs on the floor.
A Cautious Buy-Side Response
But buy-side firms still are not comfortable with high-frequency trading firms interacting with their customer order flow. "It's a mixed blessing," comments Jennifer Setzenfand, VP and senior trader at Federated Investors in Pittsburgh. "I don't like it, but I do like the fact that they are opening them up to regulatory scrutiny," she adds, suggesting that the DMM role will subject GETCO to more oversight by the NYSE and the SEC.
"You've got to keep in mind that not all high-frequency [trading] is bad," Setzenfand acknowledges. When HFT shops supply "the volume you need at the time you need it and the price that's desired, that can be acceptable. But if your information is taken away from you and used against you," that is the problem, says the buy-side trader.
As soon as the news that GETCO would take on the DMM role at the NYSE broke, buy-side firms voiced concerns to their sell-side brokers. "We had some very large clients express skepticism about if this was good for U.S. markets," relates Timothy Reilly, managing director and head of electronic execution sales for the Americas at Citi.
"For the past year, the majority of the institutional trading community has consistently asked us to avoid GETCO," notes a sell-side trading executive who requested anonymity. "However, going forward, when certain stocks are routed to the NYSE, they will be potentially trading against GETCO's designated market making unit. That said, we work in a highly regulated marketplace, and participants are mandated to route according to [Reg] NMS and best execution requirements regardless of their initial skepticism."
Some concerned buy-side firms have even instructed their sell-side algorithm providers to avoid GETCO's dark liquidity pool, known as GETCO Execution Services, according to the sell-side trading executive. GETCO Babulak explains that although GETCO only markets the dark pool to sell-side firms, buy-side firms can receive executions from GETCO's ATS through their sell-side algo providers.
But institutions no longer can avoid interacting with GETCO now that it is a DMM. Under the NYSE's revised rules, as long as the DMM is quoting at the inside price (NBBO), it trades on parity with the other exchange members, meaning it can jump to the front of the line for a piece of the order.
"Parity means it's not pure price-time priority. If the DMM is at the NBBO and an order comes in, the DMM may get a piece of that order," explains Babulak. "It's an incentive to post quotes at the NBBO."