Ken Griffin’s money machine: market maker Citadel Securities

In July, Ken Griffin paid a record $45mn for a near-immaculate 11-foot tall stegosaurus skeleton called “Apex” — a fitting purchase for a billionaire that many consider the apex predator of finance.

In a Sotheby’s press release announcing the sale, Griffin said: “Apex was born in America and is going to stay in America”. It was a heavy hint of Republican-supporting Griffin’s thinly-veiled political ambitions, which are being bankrolled by his estimated $43bn fortune.

The two companies to which he owes that wealth have similarly gargantuan aspirations — but no such geographical sensitivities.

Griffin made his name through his hedge fund Citadel, now the most profitable investment firm in the industry’s history. But a larger chunk of his Forbes-calculated net worth actually comes from Citadel Securities — valued at $22bn when venture capitalists Sequoia and Paradigm bought a small stake in the market maker two years ago.

Citadel Securities is at the forefront of a new breed of trading firms that have eaten away at the traditional dominance of big banks.

In just two decades it has become the world’s biggest buyer and seller of stocks in the United States; in August, more equity trading was conducted within its electronic ecosystem than on the New York Stock Exchange’s main market.

Last year it generated profits of $2.8bn on net revenues of $6.3bn. In the first six months of this year alone, it made $4.9bn in net revenue.

A firm that already handles one in four US equity trades and is a major player in Treasuries has now set its sights on new targets: among them China’s vast but politically sensitive equity market, the European government bond market, and the hitherto bank-dominated world of corporate fixed income trading.

It is unlikely to settle for becoming a minor player in any of them. “We don’t enter a business just to make a little money. We enter a business to be number one. Every single time,” said Matt Culek, Citadel Securities’ chief operating officer.

It is that success which has bred a new set of challenges for future growth, according to dozens of interviews with insiders, competitors and analysts, as watchdogs have begun to scrutinise more closely how risks have shifted from traditional banks to their non-bank rivals since 2008 — and whether regulation now needs to catch up.

“The key risk is that the regulator looks at the likes of Citadel Securities and Jane Street, sees the risk there and then decides to regulate them like a bank,” said a top executive at a major bank. “Then you go from an infinite return on equity business to a mid-teens [one].”

Citadel Securities was first set up inside Griffin’s hedge fund Citadel in 2002, as markets were migrating from trading pits to server rooms.

While the hedge fund succeeded because of Griffin’s deft understanding of convertible bond markets, Citadel Securities rode the wave of the electronification of markets to become one of the largest market-makers in the world.

In simple terms, market-making involves quoting buy and sell prices simultaneously for a stock, bond, or derivative and profiting from small differences in prices.

In its early days, Citadel Securities focused on equities and options, deploying mathematical prowess and computational power to price securities quickly and accurately. But the upheaval of the crisis of 2008 helped create a new financial order — one that was the perfect environment for Citadel Securities.

That year was a moment of divergence for Griffin’s two firms: a near-death experience for the hedge fund and a stellar year for Citadel Securities which was spun out, as investment banks retreated, liquidity vanished and volatility soared, allowing market-makers to collect a huge premium for their services in the panic.

The European business of Citadel Securities made almost $461mn in trading income that year, filings show: a feat that it would not repeat in the next decade.

Griffin split the businesses and the two have operated separately ever since — to a point. Front office staff act independently, with separate management, trading and technology teams, and Griffin now has only a non-executive role at Citadel Securities. Beijing-born Peng Zhao, a Citadel Securities lifer, has served as chief executive since 2017.

But both firms remain owned by Griffin, are housed under the same roof in both London and New York, and share teams in operations, trade financing, and treasury management.

Citadel Securities bridles at any insinuation that the businesses are not entirely separate. “It’s no different to Goldman Sachs Asset Management and Goldman’s markets business,” one insider said. However, employees are under no illusions of Griffin’s influence on a culture that is said to be more competitive, corporate and hierarchical than many of its rivals.

“When you put up numbers you will be well rewarded. When you don’t you will be shot. It’s very simple,” said one former Citadel Securities employee.

Citadel Securities said that it “attracts exceptionally bright and motivated professionals capable of solving the world’s most complicated financial problems” and that it “expects and rewards excellence from those who contribute to our mission of delivering a superlative experience for [its] clients.”

Citadel Securities used its independence to build a business that is simultaneously a trading partner, client and rival to the trading firms, hedge funds and banks it deals with.

At the core of the Citadel Securities model is order flow. It uses the information from the $450bn worth of trades it executes every day to power its predictive analytics — the product of spending hundreds of millions a year on hard tech and quantitative research, according to one insider — and estimate the fair value of equities and options in all market conditions.

The reams of data also supply the material for its proprietary trading business: something that insiders say is now a significant profit centre for the firm. The firm says it makes the trades it executes publicly available.

Citadel Securities’s pricing is ultra-competitive and margins in the business are slim. Market making is, according to the founder of one of Citadel Securities’ principal rivals, Doug Cifu of Virtu, a business of “hitting singles”.

“We don’t try to hit doubles or triples or home runs. It’s really, really hard to be a consistent singles hitter,” Cifu said.

Competitive pricing attracts more flow, even from rivals. “The truth is, they have some of the best pricing in the business; how they do it I don’t know,” said an executive at one of the world’s biggest hedge funds. The head of a rival trading firm said: “We trade with them a lot and begrudgingly respect them.”

Flow also comes from the explosion in retail trading spurred by the sums Citadel Securities and its rivals pay brokers to send the firms their trades: $509mn in Citadel Securities’ case paid to Robinhood, Charles Schwab and ETrade in the past year, regulatory filings show.

“Payment for order flow” is banned in the UK and the European Union. Griffin has professed ambivalence about whether the practice is outlawed in the US, pointing out that it is a substantial cost. But the payments to brokers have secured vast flows for the likes of Citadel Securities and allowed the trading firms to carve up the retail trading sector between them.

More than 90 per cent of easier to execute retail orders were split between market makers who paid for flow in 2022, according to the SEC, and over a third of US-listed retail volume is executed through Citadel Securities’ platform, according to its website.

Firms are bound by rules to secure the best price for customers, and proponents say the practice has supported zero commission trading. But opponents argue there are hidden costs embedded in payment for order flow, partly due to how the segregation of the market reduces competition. Even in the US, regulators have mused on the informational advantages players such as Citadel Securities gain from the order flow.

“They will tell you that you can trade for free on Robinhood or Ameritrade, but as Milton Friedman always said there is no such thing as a free lunch,” said the head of a rival trading firm.

Citadel Securities is now applying the lessons from equities trading to other markets.

“Our success was built on exchange market making. Now we are leveraging these historical strengths to be Citadel Securities in more places,” said Jim Esposito, who was recently poached from Goldman Sachs to be the trading firm’s president.

“This means more product and geographic diversification. The number of potential growth opportunities feels almost boundless.”

One such diversification is selling a service that would allow the likes of mid-sized banks to keep their relationships with clients but let Citadel Securities handle the actual trading, and open up a new source of trading flow that has so far been out of reach.

That would represent a partnership with banks. But other opportunities would represent a more direct competition: among them the $11tn US corporate bond market, a vast but inhospitable business traditionally built on relationships.

The challenge in credit markets is that they are made up of hundreds of thousands of unique securities, making trading in them far harder to truly automate than equities.

Because of that, corporate debt has long been dominated by big investment banks such as JPMorgan and Goldman Sachs which built huge franchises based on big balance sheets and shared history.

“The global investment banks have direct relationships with corporate clients like big infrastructure companies that are large repeat bond issuers,” said Chris Concannon, chief executive of electronic trading platform MarketAxess.

Attempting to take on the investment banks on that turf is akin to “going from playing home games in equities to playing away games in fixed income,” said one executive at a large US bank.

Citadel Securities and its rivals see an opening, however.

Average trade sizes are coming down, volumes are rising and speeds are increasing — just like what happened in equities two or three decades ago. Algorithmic trading is on the rise. Jane Street, a major competitor to Citadel Securities, has already made inroads into credit trading thanks to its dominance of exchange traded funds that invest in bonds.

“Citadel and others have a real expertise in anonymous market-making from equities, and they are sophisticated around machine learning,” said Billy Hult, chief executive of Tradeweb.

That may mean that trust and relationships are less of a factor. “Big asset managers are more willing to entertain shifts in market structure and worry less about who is on the other side of their trade,” Hult added.

Citadel Securities is also gaining traction with corporate America, Esposito said. “Every corporate CEO and CFO wants to have a dialogue with Citadel Securities. They obsess about what’s driving the change in their company’s stock price.”

If every corporate CEO wants to rub shoulders with Citadel Securities, the firm itself has bigger ambitions — starting with its founder.

Griffin has ramped up his involvement in US politics. The billionaire has donated more than $100mn to Republican candidates, previously backing figures such as Florida governor Ron De Santis’s re-election campaign and Nikki Haley’s run to become the Republican presidential nominee.

The Florida native shifted the headquarters of his two firms from their founding city of Chicago to Miami, criticising Democrats’ governance of the Windy City on the way out.

He has become increasingly outspoken on political issues too, calling Harvard students “whiny snowflakes”, criticising the Chicago school his children attended for “indoctrinating” them with “woke” ideology, and lamenting President Biden’s economic agenda.

At the Knight-Bagehot gala dinner in New York City last month, he hinted at a presidential run.

“I would never say no to the possibility of being involved in our government,” he said. “I don’t think 2028 is that moment in my life.”

Griffin’s willingness to openly engage in politicking to achieve his goals — whether it be lobbying or diplomacy — also marks Citadel Securities out from some of its low key rivals.

When Xi Jinping welcomed a select delegation of US business executives in March to the Great Hall of the People in Beijing, among the executives hobnobbing the Chinese president were Blackstone supremo Stephen Schwarzman, FedEx president Rajesh Subramaniam and Mark Carney, former head of the Bank of England and now chair of Bloomberg LP.

Standing discreetly far to the left of the official portrait was someone who needed no translator, however: Citadel Securities’ chief executive, Peng Zhao.

Accessing China’s $12tn stock market is high on the firm’s agenda.

It is a country where Citadel Securities has had its share of setbacks. In 2015, Chinese regulators froze a Shanghai-based Citadel Securities’ trading account until 2020 as part of a broader probe over market manipulation and short sellers.

Earlier this year, Citadel Securities failed in its bid for Credit Suisse’s China securities unit, an acquisition that would have granted it licences to offer brokerage services locally.

For now, the firm has a small team in Shanghai which supports its offshore China business. But rivals say Citadel Securities has been canny about laying the groundwork for eventual approval.

“They were persona non grata for a period of time . . . just keeping their heads down,” said one person familiar with the firm’s lobbying efforts. “[But they] never miss an opportunity to make a pitch.”

Across the industry there are expectations that the status quo, which has allowed companies like Citadel Securities to expand into banks’ territory without having to deal with many of the regulations that constrain them, is unlikely to remain.

At the end of last year, US regulators updated their old playbook for regulating large non-bank institutions, previously used on sprawling insurers like Prudential, MetLife and AIG.

SEC chair Gary Gensler has shown considerable appetite for regulating firms including hedge funds and trading groups.

If there are any major market upsets caused by a rogue trading algorithm for instance, it could impact confidence in markets.

“There is a history of algos going haywire,” said a senior prime broking executive at a bulge bracket bank. “There is a lot of risk moving out of banks to sectors that aren’t as closely regulated and that seems to be a gap.”

Citadel Securities does not see it like that, however.

It emphasises its registration as a broker-dealer, like other banks, and its oversight by regulators including the SEC and CFTC. It argues it has been a force for transparency in the industry through the reporting of its trades to regulators and the wider market.

It does not anticipate a regulatory crackdown. And public records show the efforts it has expended on meeting the regulators who might impose one.

When Gensler took office in 2021, Griffin secured a meeting with the SEC chair before the chief executives of Citigroup, Bank of America, Goldman Sachs or Morgan Stanley.

The joint lobbying team the firm shares with Citadel met Gensler 18 times in three years, significantly more than any of its close rivals, and rivalling the number of meetings of the country’s bulge-bracket banks.

Nonetheless, as the firm has grown, so has its potential impact on the wider financial system — not least because Citadel Securities and its peers use banks to facilitate derivatives trading. When the family office Archegos defaulted on derivatives trades in 2021, it caused billions of dollars in losses to banks including Credit Suisse, Morgan Stanley and Nomura.

“If one of them [the large market makers] goes down, the whole system will be impacted, just like a bank,” said a senior prime broking executive at a large US bank, which lends to market makers including Citadel Securities.

“We saw Archegos go down . . .[and its] importance to the [financial] system, to the marketplace, was not even close to Citadel.”