Jane Street Group LLC and Citadel Securities are on a tear. First-half revenue at the two predominantly electronic market makers grew about 80% compared with the first six months of 2023, according to Bloomberg News. That’s enough to make traditional Wall Street executives green with envy — but these upstarts aren’t going to completely devour the old guards’ lunch.
The biggest investment banks such as Goldman Sachs Group Inc. and JPMorgan Chase & Co. have spent years cultivating more complex, higher-margin trading and lending activities that these newer market makers don’t touch. And unless their business models change, they probably never will.
Competition between the big banks and the less tightly regulated electronic interlopers is getting hotter for sure. Jane Street and Citadel Securities have grabbed ground from their storied peers by being smarter, quicker and more efficient, engaging better technology and enjoying lower fixed costs than traditional banks, including for people, capital and regulation.
The spectacular growth of the two firms puts them on course for record revenue this year, according to Bloomberg News. Jane Street’s net trading revenue of $8.4 billion in the first half puts it more than $3 billion ahead of the total equities and fixed-income trading revenue of both Barclays Plc and BNP Paribas SA. It was behind Barclays in full-year revenue in 2022 but overtook the UK bank’s markets division last year in dollar terms.
Citadel Securities still lags the two Europeans but is catching up fast: Its $4.9 billion net trading revenue so far this year is only just behind BNP’s $5.1 billion – and this is after a spell when BNP expanded its equities trading with the full acquisition of stockbroker Exane and Deutsche Bank AG’s prime broking teams that serve hedge funds.
The two US market makers have ridden the wave of electronification of markets, initially in stocks and futures trading, but increasingly also in other derivatives and fixed income. Other electronic peers such as Virtu Financial Inc. or Flow Traders Ltd. have stuck more to an agency model, simply executing trades for investors and taking little risk themselves; Citadel Securities and Jane Street have invested in bigger balance sheets to carry inventory and take positions in markets, juicing revenue further.
Credit exchange-traded funds and further electronification of fixed income markets will likely drive the next wave of growth for electronic market makers. Jane Street is already a big player in credit, while Citadel Securities has been building credit trading capabilities more recently.
Stocks, futures, options and credit default swaps are already more than 80% electronically traded rather than by phone or messages, according to analysts at Bank of America Corp. The non-bank market makers command a dominant share of those asset classes, but they only handle about 10% of US corporate bond trading and 20% of Treasuries, although Jane Street is already a top-10 dealer on the MarketAxess platform, the analysts estimate.
That’s set to change. Investors are getting more comfortable trading bonds electronically and the growth of ETFs has made it easier to sell portfolios of hundreds of bonds electronically in one go. Where some investment banks still have an edge is in pricing and selling rumps of less liquid, less fancied bonds out of a portfolio that aren’t wanted in any ETF. In the US, portfolio trades and all-to-all trades, where investors can beam sell orders to multiple dealers and non-bank market makers at the same time, were the fastest growing types of credit transactions on Tradeweb Markets Inc. between 2020 and 2023, according to Bank of America.
Still, there are some areas where investors still prefer to use traditional dealers. Large block trades of a single security are risky for both the seller and the market maker: They can move markets, giving the seller a worse price, or leaving a risk-taking market maker with a painful loss.
At the same time, big investment banks have been investing to make their services more valuable to hedge funds, which provide much of Wall Street’s trading revenue. That means bespoke structured trades that can involve multiple assets and derivatives, as well as portfolio valuation and analytics tools, and of course financing investors’ bets in stocks, Treasuries or other bonds.
Prime broking, which is mainly lending against stocks, and fixed-income financing have been a growing part of big banks’ markets divisions in recent years. A handful have been highlighting this trend to their shareholders by disclosing financing revenue. Goldman Sachs has been breaking out these numbers longest and has shown growth since 2020 in dollar terms and as a share of trading revenue. Jane Street and Citadel Securities won’t be going after this lending business without becoming a different kind of business.
The biggest investment banks with the greatest trading flows will be able to remain competitive with the electronic market makers in the most liquid, highest volume and simplest trades. They have enough revenue to absorb the higher fixed costs of being a bank and to invest in the technology needed to keep pace. Smaller subscale banks, however, will struggle: They might end up outsourcing trade execution to electronic challengers, while managing the client relationship. Citadel Securities is working on just such a strategy, Bloomberg News reported in July.
The rise of the electronic market makers is impossible to ignore, but is it a good thing? They tend to bring cheaper trading at tighter bid-ask spreads and more liquidity to each asset class, reducing market friction. However, this might also be encouraging the “gamification” of trading, which can exaggerate momentum or fads. That’s part of what makes Clifford Asness of AQR Capital Management LLC worry that markets are becoming less fundamentally efficient.
What’s certain is that we still know too little about how the biggest electronic market makers operate and the risks they bear. As they handle a greater share of stock, bond and other markets, it’ll be become increasingly important for broader financial stability that investors and regulators seek more transparency.
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