Friday, August 3, 2012

Knight Capital on the Brink of Extinction

I take the platinum card and put it in my jacket. The elevator doors close and my phone rings again. It is HQ to update me on the unexpected developments out of Knight Capital and the problems they face due to a proclaimed software problem which caused the company to lose $440 million. That loss has spiraled into bigger problems and may force Knight Capital into total collapse.

On Wednesday morning Knight Capital reported a software glitch which temporary impacted 140 stocks. In general the market ignored the disruption unharmed, but Knight Capital ended up with a $440 million trading loss and now seeks emergency funding. They have approached JPM, but they have refused to comment. Knight Capital claimed they are still within capital requirements and open for business as usual. That has not stopped firms like TD Ameritrade, Vanguard as well as Fidelity to stop routing orders through Knight Capital out of fear that the firm would collapse.

This software glitch will most likely result in the sale of Knight Capital or into bankruptcy. The most probable outcome of this situation is that the entity which will provide emergency funding for Knight Capital will end up with a full purchase once the storm calms down. Due to that potential bidders are quiet and evaluate their options. The only thing certain is that Knight Capital will cease to exist in its current form.

Besides JPM, Knight Capital is also in talks with Virtu Financial which in turn is backed by Silver Lake Partners. The firm has hired Goldman Sachs as well as Sandler O'Neill to advise them on their strategic options. A data room was established in order for potential bidders to evaluate their books and have the necessary information in order to make an offer.

The biggest problem is that Knight Capital does not have the luxury of time and needs to act fast as the firms collapse is imminent. This event has caused uninformed idiocy to take center stage and blame HFT for the root cause of the issue. When uninformed idiocy takes a break misguided stupidity takes over and scream for more regulation. Markets are over-regulated and offer a counter-productive environment. The problem is that current regulation is ineffective and needs to be replaced with less but effective regulation.

The competition of Knight Capital currently enjoys the short boost in business as companies avoid the firm until they receive a clear message that they are not in danger of shutting its doors for business especially after MF Global PFG. Confidence is shattered amongst the industry and this has certainly not helped bigger picture. Knight has this weekend to hammer out a solution or a rather dark Monday will follow. Knight saw its share plunge over 60% yesterday on very heavy volume which points to great problems for the company as investors sell out at a record pace.

The elevator reaches the ground level and we exit the building. My driver stands ready and the security team and I disappear into the night as we are headed back to HQ for a conference to discuss the attack and initial results of the security investigation. At least I will get access to my secure flash drive which is locked down in the vault.

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