Don’t Worry: FINRA’s Got This

This should make you feel better:

Knight Capital Group currently remains in compliance with its net capital requirements following the firm’s $440 million trading loss, a front-line financial regulator said Thursday.

The Financial Industry Regulatory Authority, an independent regulatory authority for the securities industry, said in a statement Thursday that it’s working with Knight and other regulators to “review the impact resulting from Knight Capital’s technology issue,” which occurred in early trading Wednesday.

“Finra is closely monitoring the firm’s capital, and, at present, they are in compliance with net capital requirements,” said Finra spokeswoman Nancy Condon in a statement. “Finra currently has examiners on site” at Knight’s Jersey City, N.J., headquarters, she said.

Reassuring! Some context:

That same 10-Q shows $8bn of assets, $6.5bn of liabilities, and $1.5bn of equity firmwide. Imagining for a second that leverage was constant across all of Knight’s bits and calculation methods, that 5.3x leverage means that Knight’s $318mm of total US regulatory net capital across its broker-dealer subsidiaries would have supported some $1.7bn of assets. FINRA would have been fine with that, and would also have been just as fine with $2.2 million of net capital supporting that same amount of assets, or about 770x leverage.

Also, and this may be important: 318 minus 440 is less than 1.5. I’d even ballpark it at being less than zero.

I’ll go ahead and predict that in the next few weeks somebody, probably Congress, will be yelling at NYSE and FINRA about Knight Capital. That’s kind of mean and unfair: financial institutions have every incentive and opportunity to catch money-losing mistakes, and mostly they do, and sometimes they don’t; regulators have fewer incentives and opportunities so you certainly can’t expect them to be perfect. Who would have thought that the best algo-trading firm would algo-trade so terribly? FINRA was probably too busy keeping an eye on UBS.

Still, I’m not sure that telling the market that Knight is in compliance with net capital requirements helps much. Obviously the regulatory capital cushion of its broker-dealer subs is not the same thing as Knight’s actual solvency or liquidity, and knocking $440mm off Knight’s $1.5bn accounting equity still leaves it with plenty of money. But FINRA didn’t, and won’t, tell you that. They’ll tell you that Knight has at least $2.2 million of equity left. If Knight is down to its last million or two, though, you don’t want to be the last one still hanging around.

Finra: Knight Capital in Compliance With Net Capital Rules [Deal Journal]

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