The Actual Details of the Knight Capital Error

A few days ago I speculated about the details of Knight’s error unwind with Goldman.   I got some things right, some things slightly right, and some things wrong.   The WSJ today has some fascinating details.

First, the total size of the error:

“Knight Capital Group Inc. was holding about $7 billion of stocks at one point on Wednesday last week—a far bigger figure than previously known—as a result of errant trades that forced it to seek emergency funding, according to people familiar with the matter.

Knight’s traders worked frantically Aug. 1 to sell shares while trying to minimize losses due to a software problem, ultimately paring the total position to about $4.6 billion by the end of the trading day, the people said.”

Then, the details of Knight’s reasons for trading out of the position.  I had guessed that they might not have had the capital to actually settle their trades if they traded out of them in the market, but the WSJ notes that they didn’t have the capital to hold the positions:

“The higher exposure shows that Knight’s problems could have been worse. Still, the $4.6 billion position would have prevented Knight from opening for business the next day. The brokerage firm would have lacked the capital required by regulators to offset risks from holding the stocks, said the people.”

Finally, the details of the risk bids that Knight sought from brokers to take the positions off their hands.   Remember how I guessed that Knight may have lost $ 400MM mark to market, and then paid Goldman $40 MM to take the risk?  Well according to the WSJ:

“The terms sought by the banks reflected how dire Knight’s situation was: UBS wanted an 8% to 9% discount on the position, according to people familiar with the matter.

The equities trading desk at UBS, headed by Mike Stewart, bid for the portfolio around 6:30 p.m. Wednesday, people familiar with the discussions said. Mr. Stewart was a former colleague of Knight Chief Executive Thomas Joyce’s at Merrill Lynch. The talks with UBS fell apart later that night.

Goldman ultimately negotiated buying the portfolio at a 5% discount, or about $230 million less than the value of the stocks, the people said. That amount, not previously reported, represents more than half the loss Knight disclosed on Thursday that it incurred as a result of the technology errors.

Knight lost about $200 million trading out of a portion of the $7 billion of accidentally purchased shares during the day on Wednesday last week, according to people familiar with the matter.”

This is saying that Knight lost only $ 200MM trading out of the position in the market, and that Goldman charged them a risk commission of $ 230MM to take the balance.    5% is an absolutely massive risk commission – the likes of which I’ve never even seen or heard of in my past career (by an order of magnitude, almost) – but then again, we never got involved in bidding on a $ 4.6 Billion error position where, most importantly, the entire street knows your positions already!   That’s the main reason why the big broker dealers bidding on this risk program wanted so much cushion:  everyone was gunning against them already and the affected names could be easily compiled.   It will be fascinating to see if a story eventually comes out about how much of that 5% commission Goldman managed to capture.

I’m also somewhat surprised that Knight’s mark-to-market and realized losses during the day on Wednesday were only $ 200MM.   I would have expected them to be larger, and I am assuming that the WSJ is using the same terminology that I am: in other words, that they are not saying that $ 200MM was the realized loss only on the portion that Knight liquidated.   I can’t imagine that’s what they’d be saying, as it would make no sense for the rest of the story and screw up all of the other numbers.



disclosure: no positions in $KCG, $GS


WSJ: Knight Held $ 7B of Stocks Due to Glitch

Putting Together the Pieces of the Knight Capital Group Puzzle


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