03.29.2012
By Terry Flanagan

Bats Begins Damage Limitation

During an internal meeting to discuss its next course of action, the Bats Global Markets board voted to unanimously support company president and chief executive Joe Ratterman in the wake of the initial public offering gaffe last week. Ratterman will step down as chairman, but retain his position as CEO.

Despite the move, market observers note that the change is possibly one of damage control, and more of a formality than one that will truly impose a substantial change on the way the company is run.

“The Bats board had to do something to send a concrete signal that what happened last week with the Bats IPO was unacceptable,” said Hester Peirce, senior research fellow at George Mason University. “They did about as little as they could, though. In fact, by keeping Ratterman on as CEO, the board is expressing confidence in his ability to run the exchange and fix the problems that led to Friday’s embarrassment.”

“I don’t expect any drastic change from the way they’ve been running things, aside from this IPO problem—Bats has been run well and has been on a steady growth path,” said one market participant who declined to be named.

“I don’t think this whole event will add fuel to the high-frequency trading fire, as much as it will just cement in some folks’ minds the perception that NYSE and Nasdaq are the only venues for IPOs,” added Peirce. I don’t expect Bats to give up its attempt to challenge that perception.”

“Joe continues to do a tremendous job as CEO of Bats, leading an organization which now operates the third-largest stock exchange in the U.S., Europe’s largest stock market and a growing U.S. options exchange,” the Bats board said in a statement. “We fully support his leadership, vision and strategic direction as Bats continues to enhance competition and foster innovation in markets worldwide.”

Ratterman, a founding employee of Bats, added: “I am pleased to have the continued support and endorsement of our board, whose members have played an integral part in the continued growth of Bats.”

However, as part of an enhanced corporate governance structure, the board will separate the roles of chairman and chief executive. Ratterman, who has been chairman since June 2007, will hold the position until a new chairman is named. The move is part of what the company calls its goal of “setting best corporate practices”.

The board will decide over the coming weeks if and when it should proceed with the IPO again. The company blamed a technical glitch for the problems that marred its offer to go public.

“The unfortunate circumstances of the Bats IPO was caused by a software glitch in its exchange engine,” said Hazem Dawani, chief executive of financial technology company OptionsCity. “If anything, this highlights the complexity and the integral part technology plays in the operation of major exchanges across the globe. In the last five years, the technological advances of Bats was a major factor in its success and ability to compete quickly with major established exchanges like NYSE and Nasdaq.”

The technical issues for Bats come at the same time as regulators said they would launch a probe into the communications between electronic exchanges and high-frequency trading firms. While most exchanges accept and welcome order flow from HFT firms, a few in particular thrive on it, including offering maker-taker pricing, which rewards liquidity providers. Regulators have also sent letters to a number of high-speed firms, such as Getco and Tradebot, requesting information about their trading activities and communications with exchanges, according to reports. The two trading firms also hold stakes in Bats.

“There are really two questions,” said George Bollenbacher, a financial industry consultant at technology provider Kinetix Trading Solutions. “First, will there be additional public speculation about HFT as a result of the Bats problems in general? The answer is yes, but only some of it will be informed. The second, and more important, do the problems at Bats portend bigger risks for the markets related to HFT? The answer to that is yes.

“The underlying problem is that market liquidity is no longer a function of human judgment but systems. The SEC has no real understanding about how the markets work any longer, they don’t really know what caused the flash crash, and everyone is simply waiting for another malfunction somewhere to take over the markets. Not a very comfortable place to be.”

Despite the black eye caused by the IPO mishap, Bats is keen to move on with its prior business plans, which include potential M&A activity and technology upgrades.

Coming up next will be the migration of the Chi-X Europe platform to its own technology. Chi-X Europe is home to about 20% of European equities trading, while Bats Europe is responsible for about 5%. The move will make Chi-X faster and cut its costs of technology maintenance. The technology glitch that occurred in the U.S. IPO was not related to the technology used in its European platform.

Bats also plans to expand to countries where it sees “opportunities to leverage its technology platform to capture market share”, including Canada and Brazil. Its goal is to enter “at least two new markets by the end of 2014”, according to its IPO filing documents.

The company will also look to venture outside of cash equities and options trading, where in the U.S. it commands roughly 11% and 3% market share, respectively. It will look into the trading of U.S. Treasury securities and other fixed income products, foreign exchange, U.S. futures and other derivative products.

Bats is currently under a memorandum of understanding with Claritas, a Brazilian asset management firm, to explore opportunities in the Brazilian market, including the potential creation of a new exchange. It has not made any official announcements regarding potential expansion into Canada, aside from the SEC filing.

The company will also consider strategic alliances and further M&A activity. “Our focus will be on opportunities that we believe can enhance or benefit from our technology platform, provide significant market share and profitability and are consistent with our corporate culture,” Bats said. “We believe that the establishment of a public trading market for our common stock will enhance our ability to pursue strategic opportunities by providing a currency with which to execute future acquisitions.”

Barring the day of the retracted IPO, order flow to the exchange is at normal levels. Its U.S. equities trading market share was at 10.6% on March 27, as opposed to 10.9% month-to-date. Its European market share was actually up to 24.9%, versus 24.1% month-to-date.

Founded in 2005 as an electronic communications network for trading, Bats has since grown to be the third largest exchange operator in the U.S., behind NYSE and Nasdaq. Bats operates two trading platforms in the U.S., Bats BZX and Bats BYX, as well as Bats Options, an options exchange.

It recently acquired Chi-X Europe to form Bats Chi-X Europe, a pan-European multilateral trading facility and the largest electronic trading platform in Europe with 25% market share. The transition of Chi-X Europe to Bats’ trading platform is expected to be complete during the second quarter.

Bats’ primary listings service was launched to take on NYSE Euronext and Nasdaq OMX. It plans to use a new aggressive pricing model to attract new business. Prior to the failed IPO, the first securities listed on Bats were a suite of eight BlackRock iShares exchange traded funds. The funds are linked to indexes of international stocks.

Bats announced in May 2011 its plans to go public in a $100 million initial public offering. According to industry estimates, the company is valued at just above $800 million.

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