Knight Looks To The Future With Penson Deal

Terry Flanagan

Knight Capital Group, a market maker and broker-dealer, will acquire the futures division of troubled brokerage and clearing firm Penson Worldwide in a move that will help broaden its scope.

“Knight wanted to pick up the Penson FCM [futures commission merchant] at a steep discount, which they did,” said Richard Repetto, analyst with investment firm Sandler O’Neill. “It’s a low risk way for diversification, as they bought it relatively inexpensively.”

While the deal comes amid a difficult operating environment for market participants, with trading volumes and market volatility on the decline, it does not appear that this will signal the start of further consolidation, at least for now.

“This looks to be a one-off situation based on Penson’s financial struggles,” noted Repetto. “This environment is stressing the smaller companies. It’s not widespread, but when you see an environment that continues to have a headwind, sometimes you see some of the smaller firms sell out.”

Penson Futures chief executive John Streich said that Knight would bring “financial strength” to the firm, and that the combination would result in “strong independent futures execution and clearing”.

The parties expect that the majority of the employees at Penson’s futures division will move to Knight.

The deal is valued at $5 million in cash. In addition, Penson is entitled to receive earn-out payments over the next three years based on the performance of the futures division. The deal is expected to close in the second quarter.

“Futures trading is increasingly moving toward an electronic, exchange-based model,” said Tom Joyce, chairman and chief executive of Knight in a statement. “With the acquisition of Penson Futures, Knight fills a strategic gap in the client offering with a top 30 FCM in the U.S.

The acquisition will give Knight a presence in futures clearing, plus allow it to bring its equities trading techniques and algorithms to futures. Having a futures clearing agent will also allow it to trade over-the-counter swaps.

Penson’s futures unit services more than 60 introducing brokers, high-frequency traders, hedgers, non-clearing FCMs, professional traders and exchange members. It provides futures execution, clearing and custody services to facilitate transactions among brokers, institutions and non-clearing futures commission merchants on major U.S. and European futures and options exchanges. Penson Futures also offers risk management and consultation services and operates an electronic futures trading platform for professional traders and individual investors.

Customer futures positions and segregated funds and collateral, and foreign exchange positions and margin will be transferred to Knight. Access to positions and accounts by customers will not change and the transfer of the business will not require any technology conversions. Current management of Penson’s futures division will remain in place and Penson will continue to service its introducing brokers and customers through a transition services agreement with Knight.

Penson Worldwide has been looking to restructure its operations in recent months amid ongoing financial difficulties. It has failed to produce an annual profit since fiscal year 2009 and embarked on a set of cost-cutting measures. It announced in December that it was closing its U.K. business and would sell certain related assets to third parties. The move is expected to save about $6 million per year. One month previous to this, it sold its Australian operations to BNY Mellon’s Pershing subsidiary for about $33 million.

Earlier in 2011, Penson also combined its U.S. broker-dealer and U.S. futures business into a single entity, to be called Penson Financial Services.

It most recently announced earlier this month, along with its first quarter results, that it was actively engaged in discussions for potential strategic transactions going forward. It was also negotiating with note holders on the possible exchange of new securities, all as part of its efforts to restructure its balance sheet.

Knight has also experienced some difficulties as of late, announcing that it could suffer losses of up to $35 million due to the technical problems Nasdaq OMX had matching up buy and sell orders to form the opening trades in Facebook’s IPO on May 18. Knight and other brokers are seeking reimbursement from Nasdaq for the losses.

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