The trading glitch that caused huge losses at New York City-based Knight Capital Group doesn’t imperil any of its trading partners, but it may further depress trading volume, says Fitch Ratings in a new report.
The rating agency said Friday that the large trading losses suffered by Knight Capital due to an apparent software glitch “may ultimately lead to a structural change in the equity market-making business”, but believes other firms’ exposure to Knight “is moderate and manageable”.
Fitch reports that numerous institutions that relied on Knight for part of their trading requirements have already directed their business to other market makers. And, it says it doesn’t look like any prime brokers had disproportionately high exposure to the firm. “As a result, even in a bankruptcy scenario, we do not expect any major rated institutions to suffer large losses linked to [Knight’s] difficulties,” it says.
However, Fitch warns that the episode does pose risks for equity trading volume “as many investors become more concerned about seemingly unforeseeable risks related to trading technology problems and the broader market impact of high-frequency trading systems that periodically break down.”
At a time when retail equity trading volumes have already weakened considerably, Fitch says that the Knight Capital situation could negatively affect investor sentiment and potentially erode trading volume even further.
“Over time, we believe these events may contribute to a re-assessment of counterparty risk by major trading institutions, with trades more likely going to larger, better capitalized firms that can withstand similar trading shocks without jeopardizing funding and liquidity,” it concludes.