Refining the Tools of the Trade

2015 ANNUAL REPORT

Core
Focus

KCG 2015 Annual Report

At KCG, our core focus is to be a trading firm designed for the financial marketplace of the future.

The expansion of new, innovative technologies is creating more efficient markets across asset classes and improving trading performance. Global regulations implemented to strengthen the system following the financial crisis are designed to reduce the risks posed by large financial institutions. Clients demanding greater accessibility, transparency, and choice are driving higher standards for best execution.

Since KCG’s formation, we’ve worked tirelessly to form a simpler, leaner, and more agile firm. We’ve moved from the necessary integration to a more strategic refashioning of trading, infrastructure, and support.
The core focus at KCG is to create something new.

Refining the Tools of the Trade

KCG is an independent, technology-driven financial intermediary that facilitates trading of liquid financial assets across asset classes and regions.

Refining the Tools of the Trade
KCG is an independent, technology-driven financial intermediary that facilitates trading of liquid financial assets across asset classes and regions.

KCG is particularly focused on expanding algorithmic trading, which plays to the firm’s natural strengths.

At present, KCG derives a majority of its revenues from direct-to-client U.S. equity market making for retail brokers and banks as well as providing supplemental liquidity on exchanges and alternative trading systems (ATS). One way KCG is working to improve the diversity, quality, and predictability of earnings is to grow commissions and fees from agency-based trading.

KCG is particularly focused on expanding algorithmic trading, which plays to the firm’s natural strengths.

KCG Institutional Equities encompasses algorithmic trading and sales trading in single stocks, ETFs, and programs primarily as an agent on behalf of asset managers. KCG is particularly focused on expanding algorithmic trading, which plays to the firm’s natural strengths and offers margin expansion from building scale.

Algorithms are utilized by asset managers to source liquidity across the U.S. equity market, while minimizing price slippage and controlling transaction costs. An algorithm incorporates the client’s intent, stock price, lot size, displayed liquidity, and prevailing market conditions in determining the trading strategy. Large, block “parent” orders are routinely broken up into smaller “child” orders for execution across fragmented yet fast-moving, interconnected markets. Algorithms adjust tactics as necessary in response to small price shifts resulting from the execution of “child” orders and related market activity until the “parent” order is completed.

Industry analysts estimate that direct algorithmic trading currently accounts for roughly 35 percent of all trading in U.S. equities among asset managers, with the actual percentage rising higher due to indirect trading through sales traders, program traders, and order routers.

As a leading market maker, KCG possesses development capabilities that surpass those of most securities firms. KCG employs approximately 250 quantitative strategists and traders across the firm with detailed knowledge of market microstructure. The firm develops quantitative models that evaluate data on complex situations in microseconds, utilize sophisticated technologies capable of processing one trillion operations per second, and handle multiple petabytes of data per day to inform modeling. KCG applies these resources to algorithmic trading strategies that seek to generate micro alpha for clients in every “child” order of every “parent” order, which can add up to dramatically meaningful gains over time.
KCG employs approximately 250 quantitative strategists and traders across the firm with detailed knowledge of market microstructure.
KCG sales trading is central to cultivating longstanding relationships at the largest U.S. asset managers, which account for a disproportionate amount of total institutional trading activity. The efforts are demonstrating results. Among the top 25 firms on the II300, Institutional Investor’s annual ranking of U.S. asset management firms by assets under management, KCG trade volumes from algorithmic trading rose 43 percent in 2014 and a further 72 percent in 2015.

Bringing the Best Talent to the Table

KCG is undergoing a fundamental redesign of its global workforce.

Bringing the Best Talent to the Table
KCG is undergoing a fundamental redesign of its global workforce.
The approach to human capital is simple. KCG recruits specialized talent from leading firms as well as direct from top graduate and undergraduate programs. The firm focuses on individual development, emphasizing collaboration, upgrading technical skills, and developing leadership skills. KCG is allowing its new culture to continue to naturally emerge and take hold, underpinned by essential values and behaviors established at KCG’s inception.
The firm focuses on individual development, emphasizing collaboration, upgrading technical skills, and developing leadership skills.
At the start, the firm had just over 1,600 full-time employees. KCG formed the senior management team gradually through a series of internal appointments and new hires. Initial reductions in the firm’s overall headcount followed from the completion of asset sales and elimination of redundancies in support functions. The firm has actively added new employees in select disciplines, predominantly quantitatives and technologists, as well as in regions including Europe.

Recruiting from top graduate and undergraduate programs is central to KCG’s strategy for human capital. The firm cultivates select educational institutions, providing knowledge on the global securities markets, trading, and technology in exchange for access to new talent that can potentially drive future growth. In the process, KCG hires Ph.D.s, masters graduates, and undergraduates from outstanding institutions and integrates them with senior practitioners, enabling the exchange of theoretical and practical knowledge through collaboration. This produces highly engaged employees who want to build a career at KCG.

The firm cultivates select educational institutions for access to new talent.

Nearly one third of all current employees joined the firm following KCG’s formation.

The continual development of senior practitioners is just as vital. KCG maintains programs designed to produce better managers and leaders across the firm. The wide-ranging curriculum is brought to life through real-world scenarios and reinforced with regular assessments. As individuals progress, the focus turns to the transformational shifts required to drive meaningful change and continual improvement.

Nearly one third of all current employees joined the firm following KCG’s formation.

A steady influx of new talent, coupled with the decline in the overall headcount, has already profoundly changed the underlying composition of the employee base. In 2014, KCG added 126 new employees and finished the year with a total headcount of 1,093. In 2015, KCG added 132 new employees and finished the year with a total headcount of 1,006. Nearly one third of all current employees joined the firm following KCG’s formation.

KCG HEADCOUNT2

2 Denotes full-time employees

Delivering on the Full Potential Value

KCG has a strong early record of definitive actions—strategic, operational, and financial—coordinated to increase the value of the firm.

Delivering on the Full Potential Value
KCG has a strong early record of definitive actions—strategic, operational, and financial—coordinated to increase the value of the firm.

As part of the consolidation and reengineering, KCG undertook a series of divestitures and closings of non-core businesses, including the recent exit of retail U.S. options market making and announced agreement to sell the DMM. The firm cut non-GAAP, non-transaction-based expenses 7.6 percent in 2015. Using funds from asset sales, free cash flow, released capital, and distributions from investments, KCG reduced debt by $715 million and repurchased $471 million in stock and warrants over the past ten quarters.

At year-end 2015, KCG’s tangible book value (TBV) per share was $14.90, compared to a TBV per share of $10.64 at December 31, 2013.

KCG is part of a subcategory of specialized, predominantly electronic trading firms emerging as alternative intermediaries to the global banks.
Among brokers, KCG is part of a subcategory of specialized, predominantly electronic trading firms emerging as alternative intermediaries to the global banks. The defining characteristics are pure-play, technology-driven, liquid, and lean. KCG’s reengineering efforts are concentrated on leveraging technology to create further operational efficiencies, specifically in trading systems and support functions.

KCG VALUATION PER SHARE

Tangible book value

Book Value

5 Based on 116.9 million shares outstanding including restricted stock units at December 31, 2014

6 Based on 90.2 million shares outstanding including restricted stock units at December 31, 2015

5 Based on 116.9 million shares outstanding including restricted stock units at December 31, 2014

6 Based on 90.2 million shares outstanding including restricted stock units at December 31, 2015

In annual planning meetings, KCG management established new targets for 2016 and 2017. Priorities for 2016 include lowering the ratio of compensation to net revenues to between 40 and 42 percent, reducing total non-transaction-based expenses to $700 million, and continuing to return capital to stockholders. The overarching priority for 2017 is to achieve a return on equity (ROE) of 10 percent.

KCG management believes the targets are achievable given the realistic underlying assumptions. For example, to reach double-digit ROE will require growth in net revenues of 3 to 4 percent in 2016 and 2017 along with further reductions in non-transaction-based expenses of 5 to 7 percent each year. KCG’s efforts will get an automatic lift as projected expenses of $30 million in 2016 from the corporate relocation, real estate consolidation and duplicative rents will substantially fall away at the end of 2016.

KCG’s reengineering is central to reducing the cost structure and attaining a scale few firms possess. The ability to grow revenues without growing fixed costs will allow KCG to deliver compelling financial results and continue to increase value for stockholders.

Letter to Stockholders

March 15, 2016

Dear KCG Stockholder,

In our second full calendar year as a new firm, KCG’s financial results did not meet our expectations. I am confident, however, that we accomplished important work that will help KCG reach its goals in 2016 and beyond.

Foremost, our financial condition continues to strengthen. At the close of the year, KCG held approximately $580 million in cash and cash equivalents on the balance sheet and more than 97 percent of assets measured at fair value consisted of liquid Level I assets. During the year, we refinanced debt to lower the effective interest rate. We also repurchased just over $375 million in stock and warrants, primarily through a $330 million tender offer completed during the second quarter. We ended 2015 with 90.2 million shares outstanding including restricted stock units, a decrease of 23 percent from the beginning of the year.

In the past year, KCG’s businesses demonstrated significant improvement, growing market share in many products. KCG market making increased average daily U.S. equity share volume from the leading 10 U.S. retail brokers by 33 percent year over year and grew total market share by more than 200 basis points. KCG algorithmic trading increased average daily U.S. equity share volume from the largest 25 U.S. asset managers by 72 percent year over year. KCG Acknowledge FI increased average daily U.S. Treasury market making notional volume 30 percent year over year. KCG BondPoint grew average daily par value traded by nearly 6 percent year over year, primarily in corporate and municipal securities. The gains softened the financial impacts from the continued strong competition for retail U.S. equity order flow, periodic lulls in institutional trading activity and dampened market volumes in certain rates products and commodities.

Although created by the merger of two mature firms, KCG approaches strategy and operations from the standpoint of a new entrant. From inception, our approach has been to evaluate each business, process, and system in order to determine how best to support the new firm’s sharpened strategic focus and future growth.

During the year, we continued to get leaner and more focused by shedding assets that were non-core, unscalable, overly complex, or simply no longer attractive from an economic standpoint. For example, in the first quarter of 2015, KCG completed the sale of FX trading venue KCG Hotspot for $365 million plus the potential for additional future payments. During the fourth quarter of 2015, KCG sold interests in several small investments including Aperture Group, which is the corporate parent of OptionsHouse. In addition, we made the decision to exit retail U.S. equity options market making and initiated the sale of our NYSE Designated Market Maker (DMM).

Driving our costs lower and increasing scale are priorities that we will continue into 2016. The efforts to reengineer technology and support functions are central to growing revenues without growing expenses and delivering stronger financial results. During the year, compensation expense declined $51 million on an operating basis and compensation as a percentage of net revenues dropped to 44.5 percent in 2015 from 47.8 percent in 2014. In aggregate, KCG’s non-compensation, non-transaction-based expenses decreased $8.8 million year over year to $363.6 million on an operating basis. Management targets for 2016 include decreasing the ratio of compensation to net revenues to between 40 and 42 percent as well as reducing total non-transaction-based expenses to $700 million in 2016 from $735.9 million in 2015.

KCG generated $1,198 million in revenues and $836 million in net revenues in 2015 on a non-GAAP operating basis. Year-over-year operating net revenues were roughly flat, adjusting for the divestitures of KCG Hotspot and KCG’s Futures Commission Merchant (FCM) in the fourth quarter of 2014. The reductions in costs enabled KCG to produce a non-GAAP pre-tax profit of $100.1 million in 2015 compared to $90.1 million in 2014. KCG’s return on equity rose to 4 percent from 3.7 percent while tangible book value per share grew to $14.90 from $11.72 over the same period.

While 2015 reflects a general improvement in our financial performance over 2014, we believe there is more we can do to reengineer our cost structure so that we have not only the mindset of a new entrant but the associated competitive advantages from an operational standpoint as well. We believe that we can streamline our cost structure to earn an appropriate return on equity (ROE) even with moderate, mid-single digit revenue growth. We also believe that by analyzing where and how we can improve our systems, we will gain a long-term competitive advantage. It is not enough for us to incrementally enhance legacy systems. In each area of our business we must answer the question: How would we build this if we were creating it today? Where our analysis uncovers gaps between the desired state and our current state, we will work to undertake improvements.

In my letter last year, I cited numerous regulatory changes that would provide tailwinds for our business including the unbundling of liquidity and execution services from other products and services banks and brokers may offer. Since last year, European rule changes with respect to unbundling commission payments have been postponed to 2018. The process of uncoupling execution services from research and other offerings by many asset managers, however, has already started. In other markets, regulators and market participants are demanding more transparency with respect to how foreign exchange orders are being handled by service providers and obligations around best execution are now a real possibility for FX dealers.

In 2015, two new issues dominated the headlines: the liquidity of the credit fixed income markets and stability of the U.S. Treasury market. As with the issues mentioned last year, liquidity and stability reflect issues coming from changes in the market participants’ ability to fund and carry positions without commensurate change in market structure. If banks are no longer able to warehouse a significant amount of risk with respect to carrying inventory due to leverage, capital, and liquidity regulations, then the market for banking products can no longer operate as if nothing has changed. Automated, transparent markets enabling many market participants to provide liquidity can create a market that is as liquid in most products as it was before the rule changes, without having to return to markets where dealers have to hold massive inventories.

Moreover, the U.S. Treasury market is about 75 percent of the size of the U.S. equity market, with only a fraction of the issues, and trades twice as much volume on a daily basis. There is no reason why the market should be transparent and real time only for the very largest participants. The market impacts the pricing of many derivative products including Treasury and Eurodollars futures. Prices also determine how financial firms finance their books, how they and their counterparties value collateral, and how analysts value future cash flows to determine what financial assets are worth in general. The current market structure, where roughly 60% of U.S. Treasuries trade without printing to any tape, does not provide the price discovery that market participants deserve.

KCG welcomes all of these prospective changes. Transparent, competitive markets can address the issues of liquidity by replacing the opaque, bilateral markets of banking products that no longer function properly under the new banking capital, leverage, and liquidity rules. We are preparing for these changes by investing in businesses that trade these products in KCG Acknowledge FI and KCG Acknowledge FX. We are continuing to invest in KCG BondPoint so it can play a larger role in bringing buyers and sellers together in credit fixed income. With all secular changes to market structure, there is a tipping point when the participants change behavior. Although we are confident these changes will happen, the timing is hard to predict.

While we prepare for more opportunities that will come our way as an independent, technology-driven securities firm, we are not counting on these changes happening in 2016. As we enter our third full year as KCG, we are focused on what we can control: returning capital to stockholders when appropriate, driving down costs across all aspects of our business, tirelessly innovating to pass on savings and lower friction costs for our clients, and leveraging technology to build a more efficient and scalable business. We are committed to doing what it takes to create long-term value for our stockholders. At some point in the future, we expect these secular changes will fully shift in our favor. The steps we are taking today will ensure that we will be ready to take advantage of that shift.

We appreciate your support and look forward to providing regular reports on progress during the year.

Sincerely, DANIEL COLEMAN
Chief Executive Officer


For a reconciliation of GAAP to non-GAAP financial results, please see Annual Report on Form 10-K for the year ended December 31, 2015.

  • Chief Executive Officer

  • Chief Executive Officer, KCG Europe Limited

  • Co-Head of Equities Client Market Making

  • Head of Technology for Client Market Making

  • Chief Human Resources Officer

  • Global Head of Equities Trading

  • General Counsel & Corporate Secretary

  • Head of Asia

  • Co-Head of Equities Client Market Making

  • Chief Operating Officer and Chief Risk Officer

  • Chief Financial Officer

  • Global Head of Quantitative and Systematic Trading

  • Chief Technology Officer

  • Chief Communications Officer

  • Head of Global Execution Services and Platforms

  • Non-Executive Chairman of the Board of Directors, KCG Holdings, Inc.
    Retired Chief Executive Officer, Federal Home Loan Mortgage Corporation

  • Chief Operating Officer of Declara, an education technology company

  • Chief Executive Officer, KCG Holdings, Inc.

  • Managing Director, General Atlantic, a private investment firm

  • President — Financial Services and Insurance, NTT Data, Inc., an IT management consulting firm

  • Managing Partner, Nyca Partners LLC, a venture capital firm

  • General Partner, Andreessen Horowitz, a private investment firm

  • Retired Partner, KPMG, a public accounting firm

  • Retired Co-Founder, GETCO

  • President and Founder, Wilton Capital Group, a private direct investment firm

Corporate Information

KCG is a leading independent securities firm offering investors a range of services designed to address trading needs across asset classes, product types, and time zones. The firm combines advanced technology with specialized client service across market making, agency execution, and venues, and also engages in principal trading via exchange-based market making. KCG has multiple access points to trade global equities, fixed income, options, currencies, and commodities via voice or automated execution. www.kcg.com

  • KCG Holdings, Inc.
    545 Washington Boulevard
    Jersey City, New Jersey 07310
    Telephone 800-544-7508
    www.kcg.com

  • KCG’s Class A Common Stock trades under the ticker symbol “KCG” on The New York Stock Exchange. The CUSIP number is 48244B 100.

  • Copies of the Annual Report to Stockholders, the Annual Report on SEC Form 10-K, Quarterly Reports on SEC Form 10-Q, Current Reports on SEC Form 8-K, Forms 3, 4 and 5 filed on behalf of directors and executive officers, proxy statements, press releases and general information are available free of charge through KCG’s website at www.kcg.com.

  • The 2016 Annual Meeting of Stockholders will be held May 11, 2016 beginning at 1:00 p.m. ET at KCG’s headquarters, 545 Washington Boulevard, Jersey City, New Jersey 07310.

  • PricewaterhouseCoopers LLP
    300 Madison Avenue
    New York, New York 10017
    Telephone 646-471-3000
    www.pwc.com

  • Sullivan & Cromwell
    125 Broad Street
    New York, New York 10004
    Telephone 212-558-4000
    www.sullcrom.com

  • Computershare Limited
    480 Washington Boulevard
    Jersey City, New Jersey 07310
    telephone 201-324-0014
    www.computershare.com

KCG Holdings, Inc. provides its offerings through its Market Making, Global Execution Services, and Corporate and Other operating segments. Securities and services are primarily offered by its regulated broker-dealer subsidiary duly registered with, and a member of, the Securities and Exchange Commission (SEC), the Securities Investor Protection Corporation and certain national, regional and foreign exchanges and self-regulatory organizations.  For 2015, the Company’s material domestic regulated broker-dealer entity was KCG Americas LLC. Securities and services were also provided by the following entities: GETCO, LLC, Knight Quantitative Trading, LLC and KCG Hotspot FX LLC. The Company’s material international regulated broker-dealer entity was KCG Europe Limited, authorized and regulated by the FCA.

Unless the context otherwise requires, “KCG,” the “Company,” “We,” or “Our” shall mean KCG Holdings, Inc. and its consolidated subsidiaries.

Certain statements contained in this Annual Report and the documents incorporated by reference containing the words “believes,” “intends,” “expects,” “anticipates,” and words of similar meaning, may constitute forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995. These “forward-looking statements” are not historical facts and are based on current expectations, estimates and projections about KCG’s industry, management’s beliefs and certain assumptions made by management, many of which, by their nature, are inherently uncertain and beyond our control. Any forward-looking statement contained herein speaks only as of the date on which it is made. Accordingly, readers are cautioned that any such forward-looking statements are not guarantees of future performance and are subject to certain risks, uncertainties and assumptions that are difficult to predict including, without limitation, risks associated with: (i) the inability to manage trading strategy performance and sustain revenue and earnings growth; (ii) the sale of KCG Hotspot, including the receipt of additional payments that are subject to certain contingencies; (iii) changes in market structure, legislative, regulatory or financial reporting rules, including the increased focus by Congress, federal and state regulators, the SROs and the media on market structure issues, and in particular, the scrutiny of high frequency trading, alternative trading systems, market fragmentation, colocation, access to market data feeds, and remuneration arrangements such as payment for order flow and exchange fee structures; (iv) past or future changes to KCG’s organizational structure and management; (v) KCG’s ability to develop competitive new products and services in a timely manner and the acceptance of such products and services by KCG’s customers and potential customers; (vi) KCG’s ability to keep up with technological changes; (vii) KCG’s ability to effectively identify and manage market risk, operational and technology risk, cybersecurity risk, legal risk, liquidity risk, reputational risk, counterparty and credit risk, international risk, regulatory risk, and compliance risk; (viii) the cost and other effects of material contingencies, including litigation contingencies, and any adverse judicial, administrative or arbitral rulings or proceedings; (ix) the effects of increased competition and KCG’s ability to maintain and expand market share; (x) the announced plan to relocate KCG’s global headquarters from Jersey City, NJ to New York, NY; and (xi) KCG’s ability to complete the sale or disposition of any or all of the assets or businesses that are classified as held for sale. The list above is not exhaustive. Because forward looking statements involve risks and uncertainties, the actual results and performance of KCG may materially differ from the results expressed or implied by such statements. Given these uncertainties, readers are cautioned not to place undue reliance on such forward-looking statements. Unless otherwise required by law, KCG also disclaims any obligation to update its view of any such risks or uncertainties or to announce publicly the result of any revisions to the forward-looking statements made herein. Readers should carefully review the risks and uncertainties disclosed in KCG’s reports with the U.S. Securities and Exchange Commission (“SEC”), including those detailed in “Risk Factors” in Part I, Item 1A of KCG’s Annual Report on Form 10-K for the year ended December 31, 2015, “Legal Proceedings” in Part I, Item 3, under “Certain Factors Affecting Results of Operations” in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Part II, Item 7, in “Quantitative and Qualitative Disclosures About Market Risk” in Part II, Item 7A, and in other reports or documents KCG files with, or furnishes to, the SEC from time to time. This information should be read in conjunction with KCG’s Consolidated Financial Statements and the Notes thereto contained in its Form 10-K, and in other reports or documents KCG files with, or furnishes to, the SEC from time to time.

Copyright © 2016 KCG Holdings, Inc. Content by KCG; Design by Thinkso Creative; Photography by Adrian Weinbrecht and Brian Pineda; Development by Rubenstein Technology Group.