Why Jane Street wins and keeps winning over and over again

Rupak Ghose is formerly a financials research analyst at Credit Suisse and head of corporate strategy at ICAP/NEX.

The latest spate of financial results illustrate a widening gap in the world of electronic market-making. Two firms that were once direct peers — Jane Street and Flow Traders — are now as far apart as Amazon and Poundland.

Both were founded roughly two decades ago — Jane Street in New York around 1999 and Flow Traders in Amsterdam in 2004 — and for a while they were seen as each others main competitors in the burgeoning ETF industry, where they are both prominent market-makers.

But slowly the gap got bigger and bigger . . . and bigger. Last week Flow Traders reported that net trading revenue declined 35 per cent year-on-year to €300mn in 2023, while loan docs obtained by Bloomberg indicate that Jane Street churned out another $10bn-plus of net trading revenues last year.

That naturally caused a lot of shock, some disbelief and plenty of seething envy. Jane Street’s full-year earnings were expected to be close to Fidelity — one of the world’s largest and broadest financial empires, with over $14tn of assets under management or administration.

In recent weeks we’ve also seen results from the large investment banks that are increasingly competing with Jane Street. But none are seeing the kind of traction that the New York market-maker is. To stretch the initial analogy further, a few like JPMorgan or Goldman Sachs could claim to be the Walmarts of the industry, but like most bricks-and-mortar retailers, most investment banks trading desks are struggling.

There are four main reasons why Jane Street defies gravity: leading in fast growing markets, geography, scale, and a successful diversification strategy.

1) Jane Street generates the vast majority of its revenues from ETF trading. Industry-wide ETF trading volumes increased by 83 per cent between 2019 and 2023, and by 17 per cent from 2021 to 2023, according to Flow Traders.

Within this, growth in bond ETFs — where Jane Street is dominant — has been even faster and well ahead of growth in activity in underlying credit markets. Jane Street has thus outpaced the ETF industry.

2) Geography is increasingly destiny. The world of investment banking could fill a graveyard with European players that failed in the US. Home field advantage in the world’s largest capital markets is a huge anchor for the profitability of US investment banks.

In the world of ETF trading this is even truer. As an American firm, Jane Street has a natural advantage over European players like Flow Traders and Optiver. Europe is only 5 per cent of ETF volumes (albeit a bit larger in revenues) while the Americas is 85-90 per cent.

Like its investment banking peers, Flow Traders has struggled to crack the US market. The Americas was 51 per cent and 28 per cent of its 2023 trading volumes and revenues respectively. This compares with 45 per cent and 22 per cent for these metrics in 2019, and 44 per cent and 30 per cent in 2020. In other words, Flow Traders is trading more but eking out relatively fewer dollars from its US activity.

3) Interconnected to this is a third important factor, scale. Scale is not merely a function of overall revenues. It also comes from market share in large, profitable verticals. There are many investment banks that have similar revenues to Jane Street but with a fraction of their profitability. These banks have the complexity of being in dozens of asset classes and products but without dominating any of them (and the regulatory burden of bank supervision).

As a result, Jane Street generates 30-45x more revenue than Flow Traders with 4x as much headcount. Consequently, the former has consistently generated 70 per cent EBITDA margins in recent years while the latter saw net profit collapse to under €60mn in 2023 — what would be a bad week for Jane Street.

Privately held peers like Optiver may have higher ETF trading revenues, but the gap is still likely to be stark. By contrast, Citadel Securities — the market leader in US equities and options trading — generates 5x as much revenue as its competitor Virtu with only 60 per cent more headcount.

4) Diversification. With ETFs becoming increasingly important in the corporate bond market, Jane Street had a Trojan horse to sneak its way into a mainstay of traditional banks.

The symbiotic growth of bond ETFs with electronic and portfolio trading changed the game. Spreads compress massively as trades are sliced into smaller ticket sizes, and distributed through MarketAxess, Tradeweb and Bloomberg. Banks lost the moat of captive flow around their bilateral block trading business.

Weaker players haven’t been able to make the jump — Flow Traders fixed income and non-ETF volumes declined by mid-teen percentages in 2023. Jane Street’s business is opaque, but the chatter is that it has successfully managed to smash its way into credit trading.

Crucial to Jane Street’s journey has been its capital base, which has grown materially and is now ca $20bn. This is not only on a different scale to Flow Traders — which has less than $1bn in capital — but is on par with the credit-trading franchises of leading investment banks.

So, what can topple Jane Street? Unlike banks, Jane Street doesn’t have captive flow from an army of established clients, like companies that need to hedge currency exposures. So the franchise depends on a virtuous cycle of the best talent and technology.  

The nonbank market-maker space is littered with the bodies of trading firms that didn’t evolve, or just plain screwed up. At one point Knight Capital was one of the US stock market’s biggest traders, until its algos went haywire in 2012 and it was taken over by Getco, then the largest trading firm in US Treasuries. Then Knight-Getco was itself taken over by Virtu in 2017.

Of all the rivals, Citadel Securities stands out in size and capabilities. Moreover, Citadel Securities’ entry into corporate bond trading is a competitive threat to Jane Street, as they’re chasing the same business. They have the talent, technology, knowhow and done this before in other fixed income markets like US Treasuries.

However, in the near future, the most likely scenario is that both firms take market share from banks like Citi and Barclays, which are earning extremely low returns in their trading businesses and need to shrink their credit trading franchises. It’s a new world on Wall Street.