(June 8 – 09:15) – In a recent report Merrill Lynch reveals some of its strategy, and its expectations for the development of equity trading.
A magnanimous Merrill Lynch is maintaining its long-term “buy” rating on Knight Trading Group Inc. despite its own recent return to the market-making game with Tuesday’s US$900 million purchase of Knight rival Herzog Heine Geduld Inc.
Merrill notes that its own acquisition of Herzog “demonstrates that size and scale are needed to compete in wholesale market making”. Knight shares fell sharply on the news of Merrill’s deal, but Merrill itself says “we believe that the acquisition actually reinforces Knight’s competitive edge as a large-scale player.” It says the top three players — Knight, Merrill and Charles Schwab in that order — will continue to gain market share due to increased online trading activity, increased cross-border trading of U.S. securities, and more outsourcing.
Merrill says Knight will benefit from being the only large independent left and a possible takeover target. Merrill says it will utilize Herzog primarily to internalize most of its order flow, but it will continue to use Knight, too.
It also notes that its move to internalize order flow indicates that market makers are preferred over the much-feared electronic communications networks (ECNs) as methods of trade execution. It says ECN threats are “minimal”, and that brokerage firms will increasingly turn to outsourcing as trading profits are squeezed by decimalization.
If there is a threat to Knight, Merrill says that it comes from its intention to win volume away from the online brokers, Knight’s big source of action