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Hotspot FX: will Knight Capital be broken up?

It has been a tumultuous week for Knight Capital Group after it disclosed a $440 million loss from a computer trading glitch, which left the brokerage firm holding losing positions in multiple stocks, which it blamed on software installed earlier this week.

Knight is now desperately trying to shore up its capital base, either by a cash injection or by finding a buyer. Now the company has opened up its books to potential buyers. The Wall Street Journal reported yesterday that the firm was in talks with Virtu Financial, an electronic trading firm and market maker across multiple asset classes, about a possible deal or capital infusion. As of 9.10 a.m. New York time, the stock was down more than 60% this week to $3.24. Knight’s activities in the FX market are confined to Hotspot FX, the firm that it acquired in 2006 for $77 million, which has experienced solid growth in recent years. In June it traded average daily volumes of $31.3 billion.

According to Gerald Segel of LeapRate, the platform might well be an asset that Knight might easily dispose of separately because it is primarily an equities business, and so selling Hotspot wouldn’t be an essential element to holding that franchise together.

But who would buy it? Segal says the recent acquisition by Thomson Reuters of FXall for $625 million raises the prospect of one of its rivals acquiring it. Segal argues that Icap-EBS or State Street’s Currenex might consider taking a closer look at further consolidating the sector.

It certainly has some merit, and they would likely pick up the asset a lot cheaper than the price paid for Fxall by Thomson, which stumped up a 40% premium to acquire it last month.

However some view those as unlikely bidders. In an exclusive interview with EuromoneyFXNews published earlier this week, EBS chief executive Gil Mandelzis said the firm was very comfortable with remaining a “pure play” for inter-bank and professional FX traders, which essentially means it isn’t interested in getting into the bank-to-client business.

As for Currenex, the argument is that a takeover would remove one of its key competitors, but one FX e-commerce trading head EuromoneyFX spoke to today says the potential synergy benefits probably wouldn’t justify the costs.

But there shouldn’t be any shortage of interested parties looking to get an entry into FX. Sources say there are numerous private equity firms and equity market ECNs looking at the FX asset class and this might present an ideal opportunity.

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