OPINION: Déjà Vu All Over Again

Terry Flanagan

It ain’t about animal spirits or turbo-charging growth.

Rather, it’s about the decidedly non-sexy work of gaining scale and rationalizing costs to ride out a protracted period of tough times.

Hudson River Trading’s planned acquisition of Sun Trading is the latest evidence that the trading business is not having a lot of fun at the moment. The proposed transaction is the latest in a string of defensive mergers, as electronic market makers struggle to generate trading profits amid persistently low volatility. Other deals in recent years include Getco-Knight Capital, Virtu-KCG, and DRW-RGM Advisors.

There probably are more in the planning stages that we’ll know about before long.

Look, any press release announcing a merger will make happy talk about how great the combination is and why the deal makes sense. But trading-desk egos are big, so one has to believe that joining forces was Plan B, and was only reluctantly agreed to after Plan A of eating the other firm’s lunch didn’t happen. With the VIX hanging out mostly between 10 and 12 these days, it’s hard for your opinion to be much more prescient than the next person’s.

I’m dating myself here, but I covered the energy sector as a reporter for Bloomberg in the late 1990s, and today’s trading business bears a pretty good resemblance to the oil patch of that time. Replace the aforementioned merged or merging trading firms with BP-Amoco, Exxon-Mobil, Texaco-Chevron — and swap out the VIX number for the price of oil (which coincidentally, was in the $10-$12 range during the darkest days) — and you have the same situation.

Adam Sieminski of BT Alex. Brown noted that the wave of oil mergers was driven by fear. “They went through a tremendous wave of internal cost-cutting,” the analyst told the Washington Post in 1999, in comments that could easily apply to today’s trading firms. “Now they have to look for someone else’s costs to cut.”

Is it a new normal? Well the oil business recovered and has since had cycles of strength and weakness, but nothing as bad as 20 years ago. A mean-reversion argument would hold that the VIX will also go back toward historical norms at some point as well.



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