Exclusive: Citadel Securities ups ETF game as part of growth push

By John McCrank

NEW YORK (Reuters) - Citadel Securities LLC has entered the lead market making business with a small list of exchange-traded funds, and is doubling down on hiring and analytics in 2018 to keep an edge over rival electronic trading firms, according to sources and an internal memo.

A bout of volatility early this year after a two-year lull fueled record trading revenue for the privately held firm in February. Chief Executive Peng Zhao told employees in an early March memo seen by Reuters that Citadel plans to focus on adding expertise in existing and new businesses including ETFs, arbitrage, options, fixed income, currencies and commodities and low-latency trading.

Founded in 2002 by Ken Griffin, who also runs $27 billion hedge fund Citadel, the Chicago-based firm trades around one-fifth of U.S. equity options and ETF volume, and has more than 500 institutional clients in fixed income, currencies and commodities.

Like rivals, it has benefited as post-financial crisis rules caused big banks to retreat from their traditional role of providing liquidity.

Until March, however, it did no business as a lead market maker for ETFs or as a similarly designated liquidity provider on Nasdaq, areas dominated by rivals including Virtu Financial.

Graphic: https://tmsnrt.rs/2J0DJAV

The volatility slump of 2016-2017 slowed revenues industry-wide and prompted consolidation in electronic trading and market making, helping ease the way for Citadel to move in and take a slice of market share.

Virtu's $1.4 billion acquisition of KCG Holdings last August left the combined firm as lead market maker for around half of the 142 ETFs in Invesco Ltd's PowerShares unit at the time, creating concentration risks and prompting the fund issuer to approach Citadel, according to a person with knowledge of the matter.

Citadel has taken over from Virtu the role for 21 PowerShares funds with a total market value of nearly $13 billion, adding the functions of risking its own capital to buy and sell funds and maintain their liquidity to its existing ETF business, which includes services like block trading.

Zhao joined Citadel Securities as a quantitative researcher in 2006 and has headed the firm since January 2017, when he took over following a notably brief six-month stint by former Microsoft Corp executive Kevin Turner.

"While we are off to a good start, our goals for this year are very ambitious," Zhao said in the memo, referring to investing more in analytics and engineering, improving efficiency and building out new businesses.

Zhao also said that competitors likewise benefited from the market turbulence, and exposed where Citadel Securities fell short.

"In particular, there were many areas where our competitors seized on large trading opportunities that we missed or don't have the capabilities to capture today," Zhao said.

The operations side of the business could also be improved, the memo noted. During the sharp market movements in February, while the firm's systems "had reasonably robust performance, we were not perfect," Zhao said.

HIRING SPREE

To help support its ambitions, Citadel Securities has made a number of hires from banks and stock exchanges.

Citadel earlier this year hired former Goldman Sachs Group Inc executive Kelly Brennan - who led the bank's Americas-based ETF trading and sales business - to help expand Citadel's ETF business, a second source familiar with the matter said.

Goldman, which had been one of the few large banks remaining in the lead market maker role, retreated from the business last year as regulatory capital requirements made it more difficult to compete with electronic trading firms, Reuters has reported.

Other Citadel hires this year include former Societe General executive Tony Cronin to lead Treasuries trading in Europe and former New York Stock Exchange executive Richard Barry as head of client relationships.

Citadel Securities also brought in former banker and U.S. Treasury official Michael Harris as head of business development, with a focus on wooing private companies that Citadel can help take public as part of its designated market maker (DMM) business, the sources said.

The firm is the No. 1 designated market maker on the NYSE floor but had lost out on the big initial public offerings there of Alibaba Group Holdings Ltd and Snap Inc, prompting the Harris hire, two of the sources said.

In April, Citadel ran Spotify Technology SA's direct listing on the NYSE, an unusual path to public markets that was closely watched by investment banks and private tech companies.

(Editing by Meredith Mazzilli and Edward Tobin)