GFI Group 10-K 2012
Documents found in this filing:
Commission file number: 000-51103
GFI Group Inc.
Securities registered pursuant to Section 12(b) of the Act:
registered pursuant to Section 12(g) of the Act:
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes o No ý
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act. Yes o No ý
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ý No o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ý No o
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ý
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of "large accelerated filer", "accelerated filer", and "smaller reporting company" in Rule 12b-2 of the Exchange Act.
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No ý
As of June 30, 2011, the aggregate market value of the registrant's common stock held by non-affiliates of the registrant was $320,839,407 based upon the closing sale price of $4.59 as reported on the New York Stock Exchange Euronext.
Indicate the number of shares outstanding of each of the registrant's classes of common stock, as of the latest practicable date.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrant's definitive proxy statement for its 2012 Annual Meeting of Stockholders, to be held on June 7, 2012, are incorporated by reference in Part III in this Annual Report on Form 10-K.
Table of Contents
Sections of this Annual Report on Form 10-K, including, but not limited to "Legal Proceedings" under Part IItem 3, "Management's Discussion & Analysis" and "Quantitative and Qualitative Disclosures About Market Risk" under Part IIItem 7 & 7A, may contain "forward- looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements include, without limitation, any statement that may predict, forecast, indicate or imply future results, performance or achievements, and may contain the words "believe," "anticipate," "expect," "estimate," "intend," "project," "will be," "will likely continue," "will likely result," or words or phrases of similar meaning. These forward-looking statements are based largely on the expectations of management and are subject to a number of risks and uncertainties including, but not limited to, the following:
The foregoing risks and uncertainties, as well as those risks discussed under the headings "Item 7Management's Discussion and Analysis of Financial Condition and Results of Operations" and "Item 7AQuantitative and Qualitative Disclosures About Market Risk" and elsewhere in this Annual Report on Form 10-K, may cause actual results to differ materially from such forward-looking statements. The information included herein is given as of the filing date of this Annual Report on Form 10-K with the Securities Exchange Commission (the "SEC") and future events or circumstances could differ significantly from these forward-looking statements. The Company does not undertake to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.
Our Internet website address is www.gfigroup.com. Through our Internet website, we make available, free of charge, the following reports as soon as reasonably practicable after electronically filing them with, or furnishing them to, the SEC: our Annual Reports on Form 10-K; our Quarterly Reports on Form 10-Q; and our Current Reports on Form 8-K; our proxy statements on Schedule 14A, Forms 3, 4 and 5 filed on behalf of directors and executive officers; and amendments to those reports filed or furnished pursuant to the Securities Exchange Act of 1934, as amended (the "Exchange Act").
In addition, you may read and copy any materials that we file with the SEC at the SEC's Public Reference Room at 100 F. Street, N.E., Room 1580, Washington D.C. 20549. You also may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. In addition, the SEC maintains an Internet site that contains our reports, proxy and information statements, and other information regarding the Company that we file electronically with the SEC at http://www.sec.gov.
Information relating to our corporate governance is also available on our website, including information concerning our directors, board committees and committee charters, our Code of Business Conduct and Ethics for all employees and for senior financial officers and our compliance procedures for accounting and auditing matters. In addition, the Investor Relations page of our website includes supplemental financial information that we make available from time to time.
Our Internet website and the information contained therein or connected thereto are not intended to be incorporated into this Annual Report on Form 10-K.
Throughout this Annual Report, unless the context otherwise requires, the terms "GFI", "Company", "we", "us" and "our" refer to GFI Group Inc. and its consolidated subsidiaries.
We are a leading provider of wholesale brokerage services, clearing services and electronic execution and trading support products for global financial markets. We founded our business in 1987 and were incorporated under the laws of the State of Delaware in 2001 to be a holding company for our subsidiaries. We provide brokerage and trade execution services, clearing services, market data and trading platform and other software products to institutional customers in markets for a range of fixed income, financial, equity and commodity instruments. We provide execution services for our institutional wholesale customers by either matching their trading needs with counterparties having reciprocal interests or directing their orders to an exchange or other trading venue. We have focused historically on more complex, and often less commoditized, markets for sophisticated financial instruments, primarily over-the-counter ("OTC") derivatives, that offer an opportunity for higher commissions per transaction than the markets for more standardized financial instruments. In recent years, we have developed other businesses that complement our brokerage of OTC derivatives, such as cash equity and cash bond brokerage services, clearing services, market data and analytics and trading software businesses. We have been recognized by various industry publications as a leading provider of institutional brokerage and other services for a broad range of products in the fixed income, financial, equity and commodity markets on which we focus.
We offer our customers a hybrid brokerage approach, combining a range of telephonic and electronic trade execution services, depending on the nature of the products and the specific needs of our customers. We complement our hybrid brokerage capabilities with decision support services, such as value-added data and analytics products, real-time auctions, fixing and matching sessions and post-transaction services, such as straight-through processing ("STP"), clearing links and trade and portfolio management services.
During 2011, many of the financial markets in which we provide our services continued to be subject to major regulatory overhaul, as regulators and legislators in the United States and abroad have proposed and, in some instances, already adopted, a slate of regulatory changes that call for, among other things, central clearing of certain derivatives, greater transparency and reporting of derivatives transactions, mandatory trading of certain derivatives transactions on regulated exchanges or swap execution facilities and the required or increased use of electronic trading system technologies. In the United States, The Dodd-Frank Wall Street Reform and Consumer Protection Act (the "Dodd-Frank Act") was signed into law in July 2010. We are still in the midst of the rulemaking process mandated by the Dodd-Frank Act, with many rules yet to be finalized. The Dodd-Frank Act creates a new form of regulated entity known as a Swap Execution Facility (referred to herein as a "SEF") and mandates that all cleared swaps trade on either an exchange or a SEF. We intend to apply to become a SEF and this process, including the regulatory implications and risks associated with it, are discussed throughout this Form 10-K, including under the heading "Recent Derivative Market Developments" below and under "Item 1ARisk Factors."
At December 31, 2011, we employed 1,271 brokerage personnel (consisting of 1,035 brokers and 236 trainees and clerks). We serve over 2,600 brokerage, software, analytics and market data customers, including leading commercial and investment banks, corporations, insurance companies, asset managers and hedge funds, through our principal offices in New York, London, Paris, Nyon, Hong Kong, Seoul,
Tokyo, Singapore, Sydney, Cape Town, Santiago, Bogota, Dubai, Dublin, Tel Aviv, Los Angeles, and Sugar Land (TX).
Based on the nature of our operations in each geographic region, our products and services, customers and regulatory environment, we have four operating segments: Americas Brokerage; Europe, the Middle East and Africa ("EMEA") Brokerage; Asia Brokerage and Clearing and Backed Trading. Our brokerage operations provide brokerage services in four broad product categories: fixed income, financial, equity and commodity. Our Clearing and Backed Trading segment encompasses our clearing, risk management, settlement and other back-office services, as well as capital to start-up trading groups, small hedge funds, market-makers and individual traders. We also have an All Other segment, which captures revenues and costs that are not directly assignable to one of the other operating business segments, primarily consisting of our corporate business activities and operations and commercial revenues from sales and licensing of trading systems software, analytics and market data. See Note 21 to our Consolidated Financial Statements in Part II-Item 8 for further information on our revenues by segment and geographic region.
Services of Wholesale Brokers
Wholesale brokers (sometimes called "inter-dealer" brokers), such as us, operate as intermediaries in the center of the wholesale financial markets by aggregating and disseminating prices and fostering transactional liquidity for financial institutions around the globe. Wholesale brokers provide highly sophisticated trade execution services, combining teams of traditional "voice" brokers with sophisticated electronic trading systems that match institutional buyers and sellers in transactions for financial products that are listed on traditional exchanges or transacted over-the-counter. We refer to this integration of voice brokers with electronic brokerage systems as 'hybrid brokerage'. Although wholesale brokers may provide their institutional customers with access to traditional exchange products through their many STP links and electronic connections to exchanges and clearing firms, wholesale brokers do not generally provide independent clearing and settlement services.
Wholesale market trading institutions, such as major banks, investment banks, asset managers and broker-dealer firms, have long utilized the services of wholesale brokers to help them identify complementary trading parties for transactions in a broad range of equity, fixed income, financial and commodity products across the globe. These major trading firms pay brokerage commissions to wholesale brokers in return for timely and valuable pricing information, strong execution capabilities and access to deep pools of trading liquidity for both exchange-traded and OTC products.
Exchange traded and OTC Transactions
Exchange traded markets and OTC markets have generally developed and grown in parallel to each other as trading efficiencies have increased with the help of pre-trade data and analytics, trading software and automated post-trade processing and clearing services. The relationship between exchange-traded and OTC markets generally has been complementary as each market typically provides unique services to different trading constituencies for products with distinctive characteristics and liquidity needs. Increasingly, wholesale brokers cross exchange-traded products in the OTC market or direct customer orders to an appropriate exchange or other electronic trading venue for execution. Additionally, transactions executed OTC by wholesale brokers are often exchanged for an exchange-traded instrument after the initial OTC trade takes place.
Traditional stock exchanges, such as NYSE Euronext, NASDAQ OMX and the London Stock Exchange, and listed derivatives exchanges, such as CME Group and Eurex, provide a trading venue for fairly simple and commoditized instruments that are based on standard characteristics and single key measures or parameters. Exchange-traded markets rely on relatively active order submission by
buyers and sellers and generally high transaction flow. These markets allow a broad base of trading customers meeting relatively modest margin requirements to transact standardized contracts in a relatively liquid market. Exchanges offer price transparency and transactional liquidity. Exchanges are often associated or tied to use of a central counterparty clearer ("CCP"), thereby providing a ready utility for controlling counterparty credit risk.
In comparison, OTC markets provide wholesale dealers and other large institutional traders with access to trading environments for individually negotiated transactions, non-standardized products and larger-sized orders of both OTC and exchange cleared instruments. OTC markets generally serve counterparties that are professional trading institutions and wholesale dealers. These professional counterparties often have in place bilateral arrangements to offset their contingent credit risk on each other by giving or taking collateral against that risk. In some of the more significant OTC asset classes, such as U.S. treasury securities, equities, and equity and commodity derivatives, OTC trades are either "given up" to a third-party CCP, underwritten by a clearing house or exchanged for exchange-traded instruments.
The existence of both exchange-traded and OTC markets provides benefits for different sectors of the global financial marketplace. Exchange-traded markets serve the needs of both major and minor market participants for access to frequently traded, highly commoditized instruments. OTC markets, on the other hand, provide professional market participants and wholesale dealers with an arena in which to execute larger-sized transactions in a broad range of non-standardized and standardized products that are less actively traded and, often, individually negotiated. OTC markets are also conducive for trading large "block" transactions of actively traded standardized and centrally cleared instruments. Last, OTC markets often serve as incubators for new financial products that originate as relatively inactively traded OTC products before achieving a significant level of trading activity among a broader spectrum of investors.
As a result of the new regulations being passed in the United States and Europe and considered elsewhere, certain OTC derivative products will be required to be centrally cleared and traded via exchanges or SEFs. As this happens, it is expected that the OTC markets for certain products will diminish and the associated exchange and SEF markets for those products will expand. We are actively preparing to serve the resulting SEF markets. It is unclear what impact this transition will have on the relevant markets or on the demand for brokerage and trade execution services in these markets. For further information, see the discussion under "Recent Derivative Market Developments" below and "Item 1ARisk Factors."
Role of the Wholesale Broker
On most business days around the globe, wholesale brokers and other market intermediaries facilitate the execution of millions of sophisticated transactions, either on exchanges or OTC, involving trillions of dollars of securities, commodities, currencies and derivative instruments. These products range from standardized financial instruments, such as common equity securities, futures contracts and standardized OTC derivative contracts, to more complex, less standardized instruments, such as non-standardized OTC derivatives, that are typically traded between wholesale dealers, money center banks, asset managers and hedge funds. Wholesale brokers serve professional traders in these markets by assisting in market price discovery, fostering trading liquidity, preserving pre-trade anonymity, providing market intelligence and, ultimately, matching counterparties with reciprocal interests or directing their orders to an exchange or other electronic trading venue.
The essential role of a wholesale broker is to enhance trading liquidity. Liquidity is the degree to which a financial instrument can be bought or sold quickly with minimal price disturbance. The liquidity of a market for a particular financial product or instrument depends on several factors, including: the number of market participants and facilitators of liquidity, the availability of pricing
reference data, the availability of standardized terms and the volume of trading activity. Liquid markets are characterized by substantial price competition, efficient execution and high trading volume. Highly liquid markets exist for both commoditized, exchange-traded products and certain, more standardized instruments traded over the counter, such as the market for U.S. treasury securities, equities and equity and commodity derivatives. In such highly liquid markets, the services of wholesale brokers assist market participants achieve better execution or pricing, especially for larger transactions that may be privately negotiated.
In contrast to the highly liquid markets for more commoditized instruments, less commoditized financial instruments and less liquid standardized transactions, such as high yield debt and derivatives with longer maturities, are generally traded over the counter in markets with variable or non-continuous liquidity. In such markets, a wholesale broker can enhance the efficient execution of a trade by applying its market knowledge to locate bids and offers and aggregate pools of liquidity in which such professional traders and dealers may meet counterparties with which to trade. A wholesale broker ordinarily accomplishes this by contacting potential counterparties directly by telephone or electronic messaging and, in an increasing number of cases, via proprietary trading systems provided by the broker through which market participants may post prices and execute transactions. Additionally, in a relatively less liquid market with fewer participants, disclosure of the intention of a participant to buy or sell could disrupt the market and lead to poor pricing. By using a broker, the identities of the transaction parties are often not disclosed until the trade is consummated. In this way, market participants better preserve their anonymity. For all these reasons, in relatively less liquid markets for non-commoditized products, a wholesale broker can provide professional traders and dealers with crucial liquidity enhancement through in-depth market knowledge, access to a range of potential counterparties and singular focus and attention on efficient execution.
Wholesale brokers generally provide brokerage or execution services on either an agency (often called "name give-up") or matched principal (often called "riskless principal") basis. In an agency transaction, which is the conventional method of brokerage for OTC derivatives, we simply match a buyer and a seller and do not take title to or hold a position in the derivative instrument, or the underlying security, instrument or asset, at any stage of the process. In a matched principal transaction, which is a conventional method of brokerage for cash products, such as equities and corporate fixed income, we are the counterparty to both sides of the transaction and the trade is settled through a third-party clearing organization. Third party clearing organizations are able to reduce our counterparty risk by matching the trade and assuming the legal counterparty risk for the trade. In some cases, principally in the OTC cash markets, a wholesale broker may temporarily take unmatched positions for its own account, generally in response to customer demand, or enter into principal investing transactions in which the broker commits its own capital to facilitate customer trading activities.
Generally, as a market for a particular financial instrument develops and matures, more buyers and sellers enter the market, generating more transactions and pricing information. In addition, the terms of such financial instruments tend to become more standardized, generally resulting in a more liquid market. In this way, a relatively illiquid market for an instrument may evolve over a period of time into a more liquid market. As this evolution occurs, the characteristics of trading, the preferred mode of execution and the size of commissions that wholesale brokers charge may also change. In some cases, as the market matures, a wholesale broker may provide a client with an electronic screen or system that displays the most current pricing information. In addition, a market may have some characteristics of both more liquid and less liquid markets, requiring a wholesale broker to offer integrated telephonic and electronic brokering. We refer to this integrated service as hybrid brokerage. Hybrid brokerage may range from coupling traditional voice brokerage services with various electronic
enhancements, such as electronic communications, price discovery tools and automated order entry, to full electronic execution supported by telephonic communication between the broker and its customers.
For highly liquid OTC markets, such as certain U.S. Treasury and cash foreign exchange products, electronic marketplaces have emerged as the primary means of conducting transactions and creating markets. In such electronic markets, many of the pre- and post-trade activities of market participants are facilitated through an electronic medium, such as a private electronic network or over the Internet. These electronic capabilities reduce the need for actual voice-to-voice participant interaction for certain functions, such as negotiation of specific terms, and allow voice brokers to focus on executing larger-sized or "block" trades, providing market intelligence and otherwise assisting in the execution process. For many professional traders, the establishment of electronic marketplaces has increased trading profits by leading to new trading methods and strategies, fostering new financial products and increasing market volumes.
Most large exchanges worldwide, including certain exchanges in the United States, France, Canada, Germany, Japan, Sweden, Switzerland and the United Kingdom, are now partially or completely electronic. Additionally, in an increasing number of OTC markets for less commoditized products, a voice broker will often assist the customer by entering the customer's prices directly into the wholesale broker's electronic trading systems at the request of the customer so that any resulting trades can be electronically processed using STP. In many of these markets, customers may benefit from a range of electronic enhancements to liquidity, including pricing dissemination, interactive trading, post-trade processing and other technology services. As these OTC markets have adopted greater use of technology, some market participants have sought to outsource the electronic distribution of their products and prices to qualified wholesale brokers in order to achieve optimal liquidity and to avoid the difficulty and cost of developing and maintaining their own electronic solutions.
Cash, or spot markets, exist across the fixed income, financial, equity and commodity product spectrum. The cash or spot markets are also known as physical markets, because prices are settled in cash on the spot at current market prices, as opposed to forward prices. A cash market may be a self-regulated centralized market, such as an equity or commodity exchange, or a decentralized OTC market where private transactions occur. The cash markets are often highly liquid, commoditized markets. Wholesale brokers, such as us, provide value in these markets through the capacity to source liquidity from other market participants and efficiently transact large positions through their access to exchanges, electronic communications networks and other trading counterparties and platforms with minimal price movement. Wholesale brokers may also provide traders in these markets with critical market information and analysis.
Cash markets for equities, commodities and debt securities exist on both exchanges and in the OTC markets, while cash foreign exchange products are traded principally in the OTC markets. In cash transactions, market participants generally seek to purchase or sell a specified amount of securities, commodities or currencies at a specified price for cash, with settlement occurring within a few days after the trade is executed. In certain cash OTC transactions, the broker executes the transaction and the transaction is then cleared by a third- party clearinghouse on behalf of the parties to the trade. The clearing process reduces the counterparty risk inherent in a bilateral OTC transaction as the clearinghouse becomes the buyer and seller in the transaction, thereby guaranteeing the trade. For this service, the clearinghouse imposes margin requirements and charges a fee. When we execute transactions for certain cash products, our customers may have their own relationship with a CCP, either directly or through a third party clearing firm or prime broker. In these cases, our customers are responsible for the margin payments and other CCP fees. Once we execute the transaction, our role is to collect a commission and step out of the trade. However, in most cleared markets, including in equities and cash fixed income, we remain the counterparty until the trade is settled. We believe that central counterparty clearing will play an increasing role in the future of both the cash and derivative OTC markets.
The Derivatives Markets
Derivatives are widely used to manage risk or take advantage of an anticipated direction of a market by allowing holders to guard against gains or declines in the price of underlying financial assets, indices or other investments without having to buy or sell such underlying assets, indices or other investments. Derivatives derive their value from the underlying asset, index or other investment that may be, among other things, a physical commodity, an interest rate, a stock, a bond, an index or a currency. Derivatives enable mitigation of risks associated with interest rate movements, equity ownership, changes in the value of foreign currency, credit defaults by large corporate and sovereign debtors and changes in the prices of commodity products.
Historically, the lower capital utilization of derivatives made these products a more efficient and attractive medium for trading than cash markets for many professional market participants. For this reason, trading volumes in derivatives were frequently a multiple of volumes in the equivalent underlying cash markets. However, with the passage of the Dodd-Frank Act and other regulations abroad, regulators are likely to increase the net capital requirements or require additional dedicated collateral to support the trading of many derivative products, which may impact trading volumes for the affected derivatives.
Derivatives may be exchange-traded or traded in the OTC market. Exchange-traded derivatives, including "options" and "futures," are highly commoditized instruments featuring standardized terms, including delivery places and dates, volume, technical specifications, and trading and credit procedures. Exchange-traded derivatives are generally cleared through a CCP. Wholesale brokers, like us, often match exchange-traded derivatives as OTC transactions and the trades are then either exchanged for exchange-traded instruments, such as a futures contract, or "given up" to an exchange, other third-party CCP or futures clearing merchant ("FCM") for clearing. We have relationships with FCMs through which we are able to give up our customer's exchange-traded futures and options for clearing and settlement. On a limited number of our desks focusing on exchange-traded or OTC derivatives, we act as principal and our FCM acts as our clearing agent. In these cases, we are responsible for providing the required collateral and margin payments.
OTC derivatives, on the other hand, are bilateral, privately-negotiated agreements that range from highly customizable derivatives with long maturities structured for a user's specific needs to very liquid, highly standardized derivatives with shorter maturities. OTC derivatives are generally structured as forwards, swaps or options. A forward is an agreement between two parties to exchange assets or cash flows at a specified future date at a price agreed on the trade date. A swap is an agreement between two parties to exchange cash flows or other assets or liabilities at specified payment dates during the agreed-upon life of the contract. An option is an agreement that gives the buyer the right, but not the obligation, to buy or sell a specified amount of an underlying asset or security at an agreed upon price on, or until, the expiration of the contract. Forwards have many of the same characteristics as exchange-traded futures and options. OTC derivative transactions can be hedged and arbitraged against both cash and related exchange-traded instruments and vice versa. However, a party generally cannot offset a position resulting from an OTC derivative against margin deposits or collateral held by an exchange. Currently, swaps tend to be traded primarily OTC, but are increasingly being cleared by CCPs. In the future, many of these cleared swaps in the U.S. will be required to be executed on an exchange or through a SEF.
OTC derivatives provide investors and corporations with a wide variety of structures to address specific risk mitigation and trading strategies. In its 2011 annual survey, Risk magazine identified 97 categories across interest rates, foreign exchange, fixed income and equity derivatives. As a result, corporations and other investors are able to offset unique types of business risks that cannot be mitigated using standardized, exchange-traded derivatives. Indeed, while many large corporations hedge some risks using the relatively limited set of exchange-traded derivatives, such as futures, they often
rely on the wide range of customizable OTC derivatives to hedge those risks for which there is no close match available on organized exchanges. Such specific hedging also allows such end users to satisfy hedge accounting requirements.
The number of different derivative instruments has grown as companies and financial institutions have developed new and innovative derivative instruments to meet industry demands for sophisticated risk management and complex financial arbitrage. Novel derivative instruments often have distinct terms and little or no trading history with which to estimate a price. Markets for new derivative instruments therefore require reliable market data, market intelligence and pricing tools, as well as the services of highly skilled and well-informed brokers.
The OTC derivatives markets are currently far larger than the exchange-traded derivatives markets. According to a recent report from the Bank for International Settlements (the "BIS"), OTC derivatives accounted for approximately 90% of the total outstanding global derivatives transactions, as of June 2011 (as measured by notional amount), with the remainder being exchange-traded derivatives. OTC derivatives markets generally feature lower and more episodic liquidity than exchange-traded derivatives markets. In these large, variably liquid OTC derivatives markets, wholesale brokers provide an essential service of liquidity aggregation and anonymous, efficient execution.
According to the BIS, the size of the global OTC derivative markets, as measured by notional amount outstanding, rose by 17.7% sequentially to $707.6 trillion in the first half of 2011 from $601.0 trillion in the second half of 2010, and 21.4% year-over-year from $582.7 trillion in the first half of 2010. This compares to growth rates of 9.6% and 21.6% sequentially and year-over-year, respectively, for notional amounts outstanding in the exchange traded derivative markets over the same periods. OTC Interest rate and foreign exchange notional amounts outstanding grew 22.6% and 21.7%, respectively, year-over-year while credit default swaps grew at a lower rate of 7.1%. The interest rate and foreign exchange growth comes largely from currency swaps and interest rate swaps, respectively, while the growth rate in the notional amount of credit default swaps outstanding was accelerated by growth in multi-name (index) products.
The 2011 BIS statistics indicate the first significant growth in the OTC derivative markets since the global financial crisis started in 2008. The compound annual growth rates in OTC and exchange-traded notional amounts outstanding over the two year period ended December 31, 2010 were 0.2% and 8.5%, respectively, compared to compound annual growth rates of 24.9% and 9.5%, respectively, over the five years ended December 31, 2008. Following the financial crisis in 2008, OTC derivative growth had lagged that of exchange-traded products due to (i) a shift in market preference towards standardized, cleared or shorter dated products that typically trade on an exchange, (ii) regulatory uncertainty and (iii) the OTC industry's effort to net derivative exposure. However, heightened volatility in the markets and significant growth in interest rate and foreign exchange notional amounts outstanding have contributed to recent growth in OTC derivative products.
On July 21, 2010, President Obama signed the Dodd-Frank Act into law. The Dodd-Frank Act was intended to reduce the risk of future financial crises and will make major changes to the United States financial regulatory system. The Dodd-Frank Act will significantly alter the way we operate portions of our OTC business in the United States. The Dodd-Frank Act gives the Commodity Futures Trading Commission ("CFTC") and SEC expansive authority over much of the OTC derivatives markets and market participants, and provides the Federal Reserve Board with authority over systemically important financial entities. Through extensive rulemaking authority granted under the Dodd-Frank Act, the CFTC and SEC will create a comprehensive new regulatory regime governing many OTC derivative
markets and market participants, including much of our OTC markets and customers. Key derivatives market provisions under the Dodd-Frank Act include:
Since July 2010, the CFTC and SEC have proposed various rules to implement the Dodd-Frank Act. Many of the rules proposed to date are not final. As with other parts of the Dodd-Frank Act, many of the details of the new regulatory regime relating to swaps are left to the CFTC and SEC to determine through rulemaking. Subject to such rulemaking, we currently expect to establish and operate a SEF and a security-based SEF.
The SEC's regulations will apply to security-based swaps, such as single name credit default swaps, certain equity swaps and total return swaps referencing a single security or loan. The CFTC's regulations will apply to non-security based swaps, such as interest rate swaps, commodity swaps and swaps based on broad-based credit and equity indices.
The CFTC's and SEC's proposed rules relating to SEFs would require, among other things, that to maintain registration as a SEF, an entity would be obligated to comply with certain enumerated core principles. These principles generally relate to trading and product requirements, compliance and audit-trail obligations, governance and disciplinary requirements, operational capabilities, surveillance obligations and financial information and resource requirements. In addition, SEFs will be required to maintain certain trading systems that meet the minimum functionality requirements set by the CFTC and SEC for trading in certain OTC derivatives that are required to be cleared.
In November 2011, the CFTC issued a final rule modifying position limits for several OTC products that we currently broker, including WTI crude oil, Henry Hub natural gas and RBOB gasoline. Presently, we are unable to assess the impact of this rule on our trading volumes, although we recognize the potential for this rule to cause reduced volumes and trade sizes on a market-wide basis as market participants are no longer able to hold positions in excess of those established by the CFTC. Our trading volumes and typical order size in these products may see a reduction in size that is commensurate with any changes in market activity caused by these new rules.
The Dodd-Frank Act also will make changes to the regulatory requirements of our customers, including large market participants such as investment banks and hedge funds. For example, many of our customers will have to register as swap dealers or major swap participants. Registration as a swap dealer or major swap participant will result in additional regulation for these entities, including greater reporting and recordkeeping requirements, higher capital and margin requirements and higher business conduct standards. They will also be required to segregate clients' or counterparties' margin in a manner similar to the segregation of futures margin. Depending on the final rules that are issued relating to swaps dealers, we may be required to register as a swaps dealer to conduct certain existing businesses and would be required to meet these additional regulatory requirements listed above.
In Europe, the European Commission published a formal proposal for OTC derivatives, central clearing parties and trade repositories regulation in September 2010, which is referred to as the European Market Infrastructure Regulation ("EMIR"). EMIR was approved by the European Parliament in February 2012 and proposes central clearing and transparent reporting requirements for OTC derivatives. The proposed rules are expected to be in-place by year-end 2012. Additionally, a consultation paper relating to the Markets in Financial Instruments Directive ("MiFID") was released in December of 2010 focusing on OTC derivatives and areas such as dark pools, high frequency trading and consolidated tape for cash equities. The paper concluded that all trading in derivatives that are eligible for central clearing should trade exclusively on regulated markets, multilateral trading facilities or organized trading facilities. Subject to final rules being adopted, we currently intend to establish and operate an organized trading facility.
In the fourth quarter of 2011, the European Commission published a draft revised Markets in Financial Instruments Directive ("MiFID II") and related draft Regulations ("MiFIR") that, if adopted, will revise and replace MiFID. The MiFID II proposals will migrate the European regulatory landscape from a principles' based system to a rule based system and extends the MiFID framework to additional asset classes and markets. These draft proposals are now subject to approval by the European Parliament and individual member states. Similar to the United States regulations, until such regulations are finalized, it is difficult to predict how our business will be specifically impacted. For additional discussion of the risks relating to these new regulatory changes, see "Item 1ARisk FactorsBroad changes in laws or regulations or in the application of such laws and regulations may have an adverse effect on our ability to conduct our business."
Our Market Opportunity
We believe the financial markets in which we operate present us with the following opportunities to provide value to our customers:
Continued Global Demand for Investment Hedging and Risk Management. In recent years, governments worldwide have issued billions of dollars of sovereign debt in order to fund financial system rescues and fiscal stimulus packages. Global corporate borrowings are also expected to increase as and when economic recovery takes hold. Investors in the sovereign and corporate debt markets will need to utilize a range of derivatives products to effectively hedge their credit, interest rate and foreign exchange related risks. Additionally, the continuing growth of key emerging market countries, such as China, Brazil and India, should lead to increased demand for basic commodities and a corresponding need for hedging instruments, such as energy and commodity futures and derivatives. These hedging activities account for a growing proportion of the daily trading volume in derivative products. In the current financial environment, we believe wholesale brokers will be needed to provide crucial liquidity aggregation and anonymous, efficient execution for those derivative products which are commonly used to hedge the risks associated with credit defaults by sovereign and corporate debtors, equity ownership, fluctuations in the value of foreign currencies and energy and commodity price volatility. We believe growing global demand for hedging and risk management will, in time, drive higher trading volumes in
the financial products and markets in which we provide our execution, market information and software services.
Increased Centralized Clearing of OTC Derivatives. Increased clearing of certain OTC derivatives has been a focal point in both the U.S. and Europe under new legislation as governments, regulators and market participants seek to improve global financial markets. International governments and regulators have pushed for the centralized clearing of credit derivatives and several exchanges and industry utilities have launched, or are in the process of developing, clearinghouses and platforms to clear certain credit, interest rate and foreign exchange derivative products. We were a leader in initiatives to launch clearing of credit derivatives and believe that the increased central clearing of credit and other OTC derivatives products that we specialize in will be an important driver of future volume growth.
Demand for Superior Execution. Sophisticated market participants around the world require efficient and effective execution of transactions in increasingly complex financial markets. We believe that in certain highly liquid markets for cash products, such as corporate fixed income and equities, the services of wholesale brokers are needed to achieve best execution, especially for larger transactions that may be privately negotiated. Wholesale brokers can source liquidity from other market participants or assess which competing markets, market makers, or electronic communications networks offer the most favorable terms of execution and efficiently transact large positions with minimal price movement. In addition, we believe that wholesale brokers, such as us, who provide hybrid brokerage services are better positioned to meet the particular needs in the broad range of markets in which we operate than competitors that do not offer this combination of voice and electronic services. In the wake of the global financial crisis and the adoption of the Dodd-Frank Act and European legislation, intermediated execution generally will be mandatory for clearable swaps transactions, which we believe will lead to increased demand for superior hybrid electronic execution facilities in certain wholesale derivatives markets, such as the North American credit derivatives and energy markets, that traditionally have under-utilized such systems. Accordingly, we believe that there will be an increased need for our trade support technology, including our hybrid brokerage systems and Trayport GlobalVisionSM products.
Opportunity for Increased Market Share. As a result of the major push for regulatory reform in the global markets, which will carry significant costs for compliance, including the need to have, maintain or expand sophisticated technology platforms, many smaller wholesale or inter-dealer brokers may cease to exist. We already operate hybrid execution platforms and have an ability to build and deploy sophisticated trade execution and support technology. As a result, we may be able to increase our market share in certain derivative markets.
Greater Importance of Product Expertise. Wholesale brokers provide important price discovery and liquidity aggregation services in both liquid and illiquid markets. The presence of a broker provides customers with market intelligence, enhanced liquidity and, ultimately, improved pricing and execution. Wholesale brokers that execute a higher volume of trades of a particular financial product and have access to more market participants are better positioned to provide valuable pricing information, and can offer superior market data and analytics tools, than brokers who less frequently serve that market. In less commoditized financial markets, including markets for novel and complex financial instruments where liquidity is intermittent, market leadership becomes more important because reliable pricing information is difficult to obtain. Market participants in these less liquid markets utilize the services of leading wholesale brokers in order to gain access to the most bids and offers for a particular product. For example, some market participants pursue trading strategies that combine credit default swaps with convertible bonds or equity derivatives of the securities of a single issuer or a basket of issuers. As a wholesale broker with high volumes of bids and offers in the credit derivative and other specialized markets and access to technology that tracks such market data against activity in correlated markets, we
are well-positioned to meet the needs of professional market participants for analytical insight, price discovery, and product expertise.
Increasing Benefits of Automated Trade Processing. The combination of hybrid execution with straight-through processing has significantly improved confirmation and settlement processes, resulting in cost savings for customers. Following the adoption of the Dodd-Frank Act, we expect to see continued demand in the markets for wholesale brokers or SEFs that have the ability to couple superior execution with automated trade reporting, confirmation and processing services.
Need for Expertise in the Development of New Markets. In order to better support their clients' evolving investment and risk management strategies, our dealer customers create new products, including new derivative instruments. Dealers also modify their trading techniques in order to better support their clients' needs, such as by integrating the trading of derivative instruments with the trading of related underlying or correlated financial assets, indices or other investments. We believe the markets for these new products and trading techniques create an opportunity for those wholesale brokers, such as us, who, through market knowledge and extensive client relationships, are able to identify these new product opportunities and to focus their brokerage services appropriately.
Continuing Globalization of Financial Markets. The continuing globalization of trading is expected to propel long term growth in trading volumes in a wide array of financial and commodity products across the globe. We believe that the economic growth of emerging markets in South America, EMEA and Asia is fueling demand for the services of wholesale brokers to foster liquidity in new and emerging markets. We believe that our presence in multiple international financial centers, including the expansion of our services in South America, EMEA, and Asia, positions us to capitalize on such demand.
Increased Demand for Trading and Broking Support Services. Our Kyte subsidiary provides clearing, risk management, settlement and other back office services to professional trading and brokerage groups in listed fixed income, foreign exchange, commodity and equity products. As a result of the regulatory uncertainty relating to large financial institutions and their proprietary trading operations, as well as compensation restrictions for employees of certain banks, some traders and brokers are seeking to start their own companies or hedge funds or otherwise partner with providers of connectivity and support services such as Kyte. We believe that the services offered by Kyte will be in further demand if proposed financial regulations requiring large banks to scale-down, sell or exit their proprietary trading operations are passed in their current form.
Our Competitive Strengths
We believe that the following principal competitive strengths will enable us to enhance our position as a leading wholesale broker:
Strong Brand and Leading Position in Key Markets. We believe that over our twenty-five year history, we have successfully created value in several brands that our customers associate with high quality services in the markets on which we focus. Our leadership in multiple markets, such as the markets for certain fixed income and equity derivatives, foreign exchange options and commodity products, has been recognized by rankings in industry publications such as Risk magazine, FX Week, Profit & Loss and Energy Risk magazine. Risk magazine has frequently ranked us as the leading broker in credit derivatives and numerous currency and equity derivative markets. Energy Risk magazine also listed GFI as Commodity Broker of the year in recent years, with top positions in natural gas and metals. We are also successfully building name recognition for our services in certain cash markets for corporate fixed income and equity securities under our "Christopher Street Capital" brand in Europe. In addition, FENICS ProfessionalTM, GFI's pricing, trading and risk management platform, is a leading analytic and risk management tool in the foreign exchange markets. Our
electronic brokerage platforms, CreditMatch®, GFI ForexMatch® and, EnergyMatch®, as well as the Trayport GlobalVisionSM products, are recognized platforms in the markets in which they serve. We believe that, because of our leading market positions, strong brands and differentiated technological capabilities, we are better positioned than many of our competitors to serve the comprehensive needs of our customers in both exchange-traded and OTC markets.
Expertise in Liquidity Formation in OTC Cash and Derivative Markets. We believe we have expertise in fostering liquidity in OTC markets for complex and innovative financial products where liquidity is harder to achieve and expert brokerage services are therefore more valuable to market participants. We have long sought to anticipate the development and growth of markets for evolving, innovative financial products in which we believe we can move early to foster liquidity, garner a leading market position and enjoy higher commissions. For example, we fostered liquidity in the credit derivative and currency derivative markets in their early stages and have grown our services offerings for these markets through the years. We have also been involved in efforts to improve the transparency and standardization of the credit derivatives market as well as the development of clearing mechanisms for credit derivatives. We have introduced hybrid execution, matching and auction technology to the fixed income and currency derivatives market globally. Similarly, we were an early entrant to the shipping, property and emissions derivatives markets. Recently, we successfully increased our brokerage services in certain cash fixed income markets. While these cash products are far more commoditized than the OTC derivatives products for which we are recognized, their trading activity is often correlated to activities in the corresponding derivatives markets, in which we are active intermediaries. We believe that our expertise in fostering liquidity in various derivatives markets gives us certain advantages when providing brokerage services in correlated cash markets. It also allows us to extend the reach of our services to a broader clientele, such as larger institutional investors and hedge funds, that are more active in cash markets than derivatives markets.
Ability to Build and Deploy Technology. We believe we have a strong ability to develop and deploy sophisticated trade execution and support technology that is tailored to the transactional nuances of each specific market. Depending on the needs of the individual markets, we deploy customized brokerage systems that leverage our range of electronic and voice execution services, which we refer to as "hybrid brokerage." For example, our customers in certain of our more complex, less commoditized markets may choose between utilizing our CreditMatch®, GFI ForexMatch® or EnergyMatch® electronic brokerage platforms to trade a range of fixed income derivatives, foreign exchange options, energy derivatives and emission allowances entirely on screen or execute the same transaction through instant messaging devices or over the telephone with our brokers.
Our Trayport subsidiary supports OTC and exchange traded markets and is a market leader in providing electronic trading software to the European energy markets. Its primary revenue source comes from trading firms desiring a single, electronic access point for all of their energy trading requirements, both OTC and exchange-traded. Trayport software also supports brokers in their electronic market operations, as well as their electronic distribution of prices to trading clients. Trayport also provides trading system technology to exchanges and clearing houses that offer connectivity to trading communities across a range of markets, including commodities, equities (cash, derivatives) and fixed income. Trayport technology accommodates electronic trading, information sharing, STP capabilities and clearing links.
We have internally built or purchased most of our core trade execution and support technology. We believe that this distinguishes us from our competitors as we are not overly beholden to the licensing rights of third party vendors and can tailor our technology offerings to serve the unique needs of our diverse product markets and customers.
Quality Data and Analytics Products. We are one of the few wholesale brokers that offers a broad array of data and analytics products to participants in the complex financial markets in which we
specialize. Our data products are derived from the historical trade data compiled from our brokerage services in our key markets. Our analytics products benefit from the reputation of the Fenics® brand for reliability, ease of use and independence from any large dealer. Our Fenics® tools are used, not only by our traditional brokerage customers, but also by their customers, such as national and regional financial institutions and large corporations worldwide. In addition, our Fenics® Trader allows approximately 300 bank, corporate and hedge fund customers around the world to have electronic access to tradable prices for currency derivatives provided by a group of global dealers using "request for quote" technology.
Clearing and Settlement Services. Through our Kyte subsidiary, which is a member of a number of leading exchanges, we provide clearing, risk management, settlement and back-office services to proprietary traders, brokers, market makers and hedge funds. The provision of these services allows us to broaden our customer base and further diversify our revenue stream.
Experienced Senior Management, Skilled Brokers and Technology Developers. We have a senior management team that is experienced in identifying and developing brokerage markets for evolving, innovative financial instruments. Our founder and chief executive officer, Michael Gooch, has over 30 years of experience in the brokerage industry. Our president, Colin Heffron, has been with our company since 1988 and, prior to becoming our president, was instrumental in developing a number of brokerage desks and leading the growth of our European operations. Reporting to them is an experienced management team that includes senior market specialists in each of our product categories. We also employed over 1,000 skilled and specialized brokers as of December 31, 2011, many of whom have extensive product and industry experience. Although the competition for brokers has been intense in recent years, we have been able to effectively hire new brokers and establish new brokerage desks in areas in which we seek to expand our operations. In addition, our in-house technology developers are experienced at developing electronic brokerage platforms and commercial grade software that are tailored to the needs of certain select markets in which we focus. Our brokers utilize this technology and market information to provide their customers with enhanced services. We believe that the combination of our experienced senior management, skilled brokers and technology developers gives us a competitive advantage in executing our business strategy.
Diverse Product and Service Offerings. We offer our products and services in a diverse array of financial markets and geographic regions providing us with a balanced revenue stream. Historically, the markets on which we focus have volume and revenue cycles that are relatively distinct from each other and have generally been uncorrelated to and independent of the direction of broad equity indices. While we primarily serve the wholesale and professional trader community, some of the markets in which we are active have seen new entrants from the ranks of hedge funds and asset managers. We think this trend will allow us, in time, to serve a broader customer base. Further, our back-office and decision support products, including our clearing and settlement services, risk management platforms, market data, analytical tools and trading system software give us an opportunity to further expand our customer base, providing revenue sources beyond our traditional brokerage customers. We believe our diverse product and service offerings provide us with an advantage over many of our competitors that may have more limited product and service offerings and, therefore, may be more susceptible to downturns in a particular market or geographic region.
We intend to continue to grow our business and increase our profitability by being a leading provider of wholesale brokerage services, data and analytics and trading system software to the markets on which we focus. We intend to employ the following strategies to achieve our goals:
Maintain and Enhance our Leading Positions in Key Markets. We plan to continue building upon the leading market share and brand recognition that we have developed for a range of OTC derivative
instruments and underlying cash securities in fixed income, financial, equity and commodity markets. We will continue deploying our specialized brokers and proprietary trading technology and systems in markets where liquidity is harder to achieve and our unique brokerage services and systems are therefore more valuable to dealers and professional traders. Building on our strength in derivative products, we plan to continue to build our brokerage capabilities in corporate bond and equity markets that have correlations to the underlying derivative markets in which we are well recognized. We also intend to continue offering our quality brand data and analytics products in certain select markets requiring reliable decision support tools. Through these means, we seek to enhance our strong reputation and long-standing relationships in existing markets, while offering additional services and serving new customers in increasingly global financial and commodities markets.
Leverage Technology and Infrastructure to Gain Market Share and Improve Margins. We intend to continue to develop and deploy technology, including proprietary electronic brokerage platforms, to further enhance broker productivity, increase customer and broker loyalty and improve our competitive position and market share. We intend to continue to pursue technological innovations, such as state of the art electronic brokerage platforms, to improve our brokers' productivity and increase our market share in key products. During 2011, we continued to see substantial use of our CreditMatch® electronic brokerage platform in Europe in both credit derivatives and cash bonds, and have seen increasing use of CreditMatch® for electronic trading of credit derivatives in North America. GFI ForexMatch®, an electronic brokerage platform for foreign exchange products that is integrated it with our Fenics® trader tools, has seen increased usage in emerging market products, particularly in Latin American products. We provide our EnergyMatch® system to certain natural gas and electric power markets in North America and Europe. We believe that there will be increased demand for our hybrid electronic brokerage platforms in many of our existing wholesale derivatives markets following the implementation of the Dodd-Frank Act. We believe that as the usage of these systems becomes more widespread, we will be able to gain increased market share. Moreover, where possible, we plan to continue to install STP connections with our customers' settlement, risk management and compliance operations, in order to better serve their needs and to provide us with additional opportunities to increase our revenues.
Continue to Identify and Develop New Products, and High-growth Markets. Our brokerage personnel headcount as of December 31, 2011 was 1,271. We plan to continue our practice of developing new brokerage desks through the strategic redeployment of experienced brokers from established brokerage desks and through the selective hiring of new brokers. Individual brokerage desks are separately tracked and monitored in an effort to drive performance. We will continue to focus on identifying high growth markets where liquidity is more valuable, thereby yielding early-mover opportunities. At the same time, we plan to continue to develop our capabilities in selected cash equities and fixed income products where we can leverage our expertise in the underlying derivatives products and long-standing relationships with the world's largest financial institutions. We also intend to continue to expand our presence globally in markets where we believe there are opportunities to increase our revenues. As part of this effort, we have grown our operations in recent years in a number of locations in South America and Europe.
Align our Business with the Goals of New Regulations. Recent U.S. and European legislation as well as pending legislative and regulatory proposals for OTC derivatives require, among other things, greater use of clearing facilities, transaction reporting, greater price transparency and mandatory execution of transactions by regulated intermediaries. Our business benefited from the introduction of clearing in the United States energy markets in the mid-2000s and we have long supported greater use of clearing for credit derivatives. We believe that increased use of clearing will bring new entrants into our markets and increase trading volumes. Similarly, we have worked with major industry participants to develop transaction confirmation and reporting protocols that will be utilized in enhanced regulatory trade warehousing. Although we already operate hybrid brokerage systems that we believe will be able to
meet the new regulatory requirements to operate as a swap execution facility, or SEF, in the United States, we intend to continue to invest in those areas of our business that will serve the goals of expected regulation, including increased market transparency.
Continue to Pursue New Customers and Diverse Revenue Opportunities. We offer our products and services in a diverse range of financial markets and geographic regions and to hundreds of institutional customers. We have been successful in expanding our wholesale brokerage customer base through new product offerings and the implementation of our proprietary technology. At the end of 2007, approximately 71% of our total revenues came from our traditional dealer bank customers. By the end of 2011, that percentage had dropped to approximately 61%. In cash markets for corporate fixed income and equities, as well as in certain energy and commodities markets, we are increasingly providing brokerage services to a broader range of customers than our traditional clientele of large primary dealers. Our data, analytics and software products and clearing services are already purchased by a broad range of customers outside of the dealer community. We intend to increase the diversity of our customer base by expanding our services to the wider professional trader community in order to lessen the impact of a downturn in any particular market or geographic region on us. We also intend to maintain the geographic diversity of our revenues. On a geographic basis, approximately 59% of our total revenues for the year ended December 31, 2011 were generated by our EMEA operations, 31% were generated by our Americas operations and 10% were generated by our operations in the Asia-Pacific region. Additionally, for the year ended December 31, 2011, no one customer accounted for more than 6% of our total revenues from all products, services and regions, and our largest brokerage desk accounted for approximately 3% of total brokerage revenues.
Strategically Expand our Operations and Customer Base through Business Acquisitions and Investments. Historically, the wholesale brokerage industry was fragmented and concentrated mainly on specific country or regional marketplaces and discrete product sets, such as foreign exchange or energy products. The industry was also predominantly focused on executing trades between large dealer banks and securities houses. Over time, however, the wholesale brokerage industry has experienced increasing consolidation as larger wholesale brokers have sought to enhance their global brokerage services and offset customer commission pressure in maturing product categories by acquiring smaller competitors that specialized in specific product markets. At the same time, inter-dealer brokers have expanded their customer base within the wholesale universe to include hedge funds, corporations and asset managers. In addition, several wholesale brokers, such as us, have acquired technology focused companies which enhance brokerage execution and pre- and post- trade analysis and processing. We plan to continue to selectively seek opportunities to grow our customer base, further our operational and technological depth and breadth and to grow our business in new and existing product areas through the acquisition of complementary businesses.
Continue to Generate Cash and Return Value to Shareholders. Our brokerage, software, analytics and market data businesses have generated significant operating cash flows that have allowed us to invest in software development, open new brokerage or trading desks and otherwise re-position our business to suit current and future market conditions. At the same time, we have been able to provide our shareholders with a consistent quarterly dividend stream since 2008. Despite the recent global financial crisis, over the past three years, we generated in excess of $214 million of positive cash flow from operations and paid in excess of $102 million of dividends to our shareholders. We believe that our cash flows also benefit from the significant amount of matched principal transactions we broker for cash products. Matched principal transactions generally settle within three days and we receive our commission much sooner than we do when we execute a trade on an agency basis. We intend to continue to invest in businesses that generate operating cash flows and to use these cash flows to continue to return value to our shareholders.
Overview of Our Products and Services
Our global brokerage operations focus on a wide variety of fixed income, financial, equity and commodity instruments, including both cash and derivative products. Within these markets we have been successful, historically, in serving the more complex, less commoditized markets for sophisticated financial instruments, primarily OTC derivatives. As the trading strategies of market participants continue to evolve and diversify, and the derivatives and cash markets continue to converge, wholesale brokers like us can bridge the gap between these markets and offer services in a number of related markets.
We support and enhance our brokerage operations by providing clearing and risk management services, trading system software, analytics and market data products to our customers. We also provide our customers with STP links and electronic connections with exchanges and clearing firms where applicable.
We provide brokerage services to our customers by executing transactions on either an agency or principal basis. In agency transactions, we charge a commission for connecting buyers and sellers and assisting in the negotiation of the price and other material terms of the transaction. After all material terms of a transaction are agreed upon, we identify the buyer and seller to each other and they then settle the trade directly. Commissions charged to our customers in agency transactions vary across the products for which we provide brokerage services.
We generate revenue from principal transactions on the spread between the buy and sell price of the security that is brokered or from an agreed commission rate that is built into the pricing of the instrument. Our principal transactions revenue is primarily derived from matched principal transactions. In matched principal transactions, we act as a "middleman" by serving as the counterparty on one side of a customer trade and entering into an offsetting trade with another party relatively quickly (often within minutes and generally on the same trading day). These transactions are then settled through clearing institutions with which we have a contractual relationship. Because the buyer and seller each settle their transactions through us rather than with each other, the parties are able to maintain their anonymity.
We generally do not take unmatched positions for our own account or gain, but may do so in response to customer demand, primarily to facilitate the execution of existing customer orders or in anticipation that future customer orders will become available to fill the other side of the transaction. Although the significant majority of our principal trading is done on a "matched principal" basis, we have authorized a limited number of our desks to enter into principal investing transactions in which we commit our capital within predefined limits, either to facilitate customer trading activities or, in limited cases, to engage in principal trading for our own account. For more information on these limits, see "Item 7A Quantitative and Qualitative Disclosure About Market RiskMarket Risk." Most of our principal transactions are executed in the OTC cash trading markets, such as the fixed income and equity markets, or in certain listed derivative markets.
Fixed Income Products. We provide brokerage services in a variety of fixed income derivatives, bond instruments and other related fixed income products. Our offices in New York, London, Sydney, Hong Kong, Singapore and Tokyo each provide brokerage services in a broad range of fixed income derivative products that may include single-entity credit default swaps, emerging market credit default swaps, credit indices, options on single-entity credit default swaps, options on credit indices and credit index tranches. We also provide brokerage services in a range of non-derivative credit instruments, such as investment grade corporate bonds, high yield corporate bonds, emerging market Eurobonds, European government bonds, bank capital preferred shares, asset-backed bonds and floating rate notes. We largely provide our services for these non-derivative fixed income products out of our New York, London, Paris, Singapore and Hong Kong offices.
We support our fixed income product execution services with CreditMatch®, our electronic brokerage platform that provides trading, trade processing and STP functionality to our customers. Consistent with our hybrid brokerage model, customers may choose between utilizing CreditMatch® to trade certain credit derivative products entirely via an electronic platform or executing the same transaction over the telephone, or via other messaging mediums, with our brokers. In Europe, our customers consistently use CreditMatch® when using our services to trade certain credit derivative products. Our customers in the Americas and Asia are also increasing their use of CreditMatch® for the pricing and execution of certain credit derivative products.
We hold an economic interest in ICE Trust, a clearinghouse for derivative instruments formed as a result of IntercontinentalExchange Inc.'s March 2009 purchase of The Clearing Corporation, a company in which we were a minority shareholder. In March 2009, ICE Trust became the first clearinghouse to clear credit derivatives. We believe that our hybrid electronic brokerage systems and STP capabilities will complement the movement to greater automation and centralized clearing in the OTC credit derivatives markets. Ultimately, we believe that centralized clearing may expand the market for OTC derivative products through added settlement efficiency and reliability.
Through Christopher Street Capital, a division of GFI Securities Limited in the UK, we offer traditional brokerage services to a broad range of customers in the cash bond markets, including investment grade and cross-over corporate debt, distressed debt, agencies, high yield debt, and asset backed securities.
Kyte Capital Management Limited, through its subsidiaries, undertakes proprietary trading, market making, and liquidity provider services on fixed income futures and options on the major U.S., European and Asian exchanges and OTC trading venues.
Financial Products. We provide brokerage services in a range of financial instruments, including foreign exchange options, exotic options, non-U.S. Dollar interest rate swaps and options, repurchase agreements, forward and non-deliverable forward contracts and certain government and municipal bond options. Exotic options include non-standard options on baskets of foreign currencies. Non-deliverable forward contracts are forward contracts that settle in cash and do not require physical delivery of the underlying asset.
We offer telephone brokerage services in our New York, London, Hong Kong, Singapore, Sydney,Santiago, Bogota and Nyon offices, augmented in select markets with our GFI ForexMatch® brokerage platform. We also offer a STP capability that automatically reports completed telephone and electronic transactions directly to our customers' position-keeping systems and provides position updates for currency option trades executed through our brokerage desks globally.
Our New York office focuses on providing brokerage services for foreign exchange option trading among the U.S. Dollar, the Japanese Yen and the Euro, which are referred to as the G3 currencies, as well as the Canadian Dollar and emerging market foreign exchange options, forward contracts and non-deliverable forward contracts and non-U.S. Dollar interest rate swaps. Our New York office also offers bond options, swap options and corporate and emerging market repo brokerage services. Our London office also covers foreign exchange option trading in the G3 currencies along with nearly all European cross currencies, including the Russian Ruble and Eastern European currencies, for which we provide brokerage services for forwards and non-deliverable forwards. In addition, our London office provides brokerage services for cross currency basis swaps, and non-US Dollar interest rate swaps and options. Our brokers in Singapore, Hong Kong and Seoul provide brokerage services for foreign exchange currency options, non-deliverable forwards and non-U.S. Dollar interest rate swaps for regional and G3 currencies. Our offices in Santiago and Bogota focus on interest rate swap and non-deliverable forward products while our Dubai office focuses on Islamic finance products.
In October 2011, we opened an office in Nyon, Switzerland that focuses on the brokering of emerging market products, including foreign exchange options, forward rate agreements, basis swaps, interest rate swaps and government bonds in CE3 currencies (Czech Koruna, Polish Zloty and Hungarian Forint), South African Rand and Turkish Lira.
Equity Products. We provide brokerage services in a range of cash-based and derivative equity products, including U.S. domestic equity and international equity stocks, Global Depositary Receipts ("GDRs"), American Depositary Receipts ("ADRs") and equity derivatives based on indices, stocks or customized stock structures.
We offer voice broker assisted equity execution services from our brokerage desks in New York, London, Dublin, Paris, Tel Aviv, Hong Kong, Tokyo and Sydney and, where appropriate, they are augmented with electronic and algorithmic trading capabilities. Through our various offices, we broker trades in the OTC market, as well as for certain exchange-traded securities and derivatives.
Our New York office provides brokerage services in cash equities, single stock options, index options, sector options, equity default swaps, variance swaps, total return swaps, convertible bonds and ADRs. Our London office provides brokerage services in equity index options, single stock options, GDRs, Pan-European equities, Japanese equity derivatives and structured equities. Our Paris office provides brokerage in Pan-European equities, structured equities, single stock and equity index options and financial futures. Our Hong Kong and Tokyo offices provide a varying degree of brokerage services in equity index and single stock options, while the Hong Kong office also provides brokerage services in ADRs and GDRs. Our Dublin and Tel Aviv offices broker primarily Pan-European and international equities.
Through Christopher Street Capital Equities, a division of GFI Securities Limited, we operate a cash equities brokerage desk that provides independent equity research focused on the relationship between the credit and equity markets. Our research analyzes the relationship between credit default swap and equity markets using our historic credit default swap data. Christopher Street Capital Equities focuses, in particular, on situations where credit default swap spreads and equity prices diverge outside their normal relationship.
Kyte Capital Management Limited, through its subsidiaries, undertakes proprietary trading, market making, and liquidity provider services on cash equities and equity futures and options on the major U.S., European and Asian exchanges and OTC trading venues.
Commodity Products. We provide brokerage services in a wide range of cash-based and derivative commodity and energy products, including oil, natural gas, biofuel, electricity, wet and dry freight derivatives, dry physical freight, precious metals, coal, property derivatives, emissions, ethanol and soft commodities.
We offer telephonic brokerage supported by electronic platforms and post-trade STP and confirmation services in certain markets. Our Trayport subsidiary is a leading provider of electronic trading software and services to the European OTC energy markets, including electricity, natural gas, coal, emissions and freight. Trayport's GlobalVisionSM platform accommodates electronic trading, information sharing, STP capabilities in commodity and financial instruments and clearing links to NOS Clearing ASA, LCH Clearnet and CME ClearPort. In London, our telephonic brokerage capabilities are augmented with electronic brokerage capabilities licensed by our wholly-owned subsidiary, Trayport. In North America, we offer EnergyMatch®, an electronic brokerage platform for trading OTC energy derivatives which is currently used in varying degrees in certain electricity, natural gas and emissions markets. We intend to continue to expand this platform to other energy markets. Through EnergyMatch®, we offer STP capabilities and clearing links to CME ClearPort and other third party clearing providers.
From our New York area offices, we provide brokerage services in natural gas, oil and petroleum products, electricity, ethanol and soft and agricultural commodities. Through our Amerex subsidiary based in Sugar Land, Texas, we provide brokerage services in natural gas, electricity, environmental commodities and retail energy management. Our London office provides energy product brokerage services in many European national markets, including for electricity, coal, emissions and gas. The London office also provides brokerage services in property derivatives, dry and wet freight derivatives and dry physical freight. Our Singapore office brokers dry freight derivatives and dry physical freight. Desks in our New York, London and Sydney offices also provide brokerage services for the global precious metal markets.
Through collaboration with certain divisions of CB Richard Ellis Group Inc., we provide and continue to develop brokerage services in European property derivatives. The collaboration in the U.K. is a leader in the property derivatives market.
Through a joint venture with ACM Shipping Limited, we offer hybrid telephonic and electronic brokerage of wet freight derivatives in London, Singapore and New York.
Clearing and Settlement Services. On July 1, 2010, we acquired a 70% equity ownership interest in each of The Kyte Group Limited and Kyte Capital Management Limited, and will acquire the remaining 30% equity interest in 2013. Kyte, which is a member of leading exchanges including NYSE Euronext, NYSE LIFFE and Eurex, provides clearing, brokerage, settlement and back-office services to proprietary traders, brokers, market makers and hedge funds. In some instances, Kyte provides capital to start-up trading groups, small hedge funds, market-makers and individual traders. We acquired Kyte because of its expertise in listed derivative markets, its risk management platforms and its unique clearing, broking and investment services business model.
Software, Analytics and Market Data. Our Trayport subsidiary licenses multi-asset class electronic trading and order management software to brokers, exchanges and traders in the commodities, fixed income, currencies and equities markets. Trayport's GlobalVisionSM products have an industry leading position in supplying software to the European OTC energy markets, including electric power, natural gas, coal, emissions and freight. Trayport's primary source of revenue is from recurring license fees charged to trading and brokerage firms that are calculated by the number of active users. Trayport also receives consulting and maintenance fees to "white-label" or customize its products according to customer needs. Trayport's products provide customers with STP capabilities and clearing links to multiple clearinghouses, including NOS Clearing ASA, LCH Clearnet and CME ClearPort.
Within foreign exchange option markets, our GFI FENICS® division licenses FENICS® Professional, which provides customers with technology to control and monitor the lifecycle of their foreign exchange options trades. Sold on a subscription basis through dedicated sales teams across the globe, FENICS® Professional is a suite of price discovery, price distribution, trading, risk management and STP components. This array of modules permits customers to quickly and accurately price and revalue both vanilla and exotic foreign exchange options using math models and independent market data. Our GFI FENICS® division also recently launched a service through which approximately 300 bank, corporation and hedge fund customers around the world will have electronic access to tradable prices for currency derivatives provided by a group of global dealers using "request for quote" technology.
Through our GFI Market Data division, we license market data to third parties in the following product areas: foreign exchange options, credit derivatives, emerging market non-deliverable forwards and interest rate swaps, equity index volatilities, interest rate options and European and North American energy. We make our data available through a number of channels, including streaming data feeds, file transfer protocol downloads, directly from FENICS® Professional and to data vendors, such as ThomsonReuters and Quick, who license our data for distribution to their global users. Revenue
from market data products consists of up-front license fees and monthly subscription fees, royalties from third party market data vendors who re-license our data and individual large database sales.
As of December 31, 2011, we provided brokerage services, clearing services and data and analytics products to over 2,600 institutional customers, including leading investment and commercial banks, large corporations, asset managers, insurance companies, hedge funds and proprietary trading firms. Notwithstanding our large number of customers, we primarily serve the wholesale and professional trader community that regularly transact in global capital markets, including many of the world's money-center banks and wholesale dealers such as Bank of America, Barclays Bank, BNP Paribas, Citigroup, Credit Suisse, Deutsche Bank, Goldman Sachs, JPMorgan Chase, Morgan Stanley and UBS. Despite the importance of these large financial institutions to our brokerage business, no single customer accounted for more than 6% of our total revenues from all products and services globally for the year ended December 31, 2011. Customers using our Fenics branded analytics products and our market data products and services include small and medium sized banks and investment firms, brokerage houses, asset managers, hedge funds, investment analysts and financial advisors. We also license our Trayport trading systems to various financial markets participants, including our major wholesale brokerage competitors, exchanges and trading firms.
Sales and Marketing
In order to promote new and existing brokerage, data and analytics and software services, we utilize a combination of our brokerage personnel, internal marketing and public relations staff and external advisers in implementing selective advertising and media campaigns. Our brokerage services are primarily marketed through the direct and fairly constant interaction of our brokers with their customers. This direct interaction permits our brokers to discuss new product and market developments with our customers and to cross-sell our other products and services. We also participate in numerous trade-shows to reach potential brokerage, data and technology customers and utilize speaking opportunities to help promote market specialists and trading technologies in our core products and services.
Our data, analytics and trading software products are actively marketed through dedicated sales and support teams, including at our Trayport subsidiary, that market products to customers globally. As of December 31, 2011, we employed a total of 121 sales, marketing and customer support professionals globally.
Pre-Trade Technology. Our brokers generally use an internally developed suite of proprietary market data and analytical software tools to assist customers with their trading decisions. This technology is often made available directly to customers via a license agreement. In most cases, our brokerage desks distribute prices and other market data via our proprietary network, data vendor pages, secure websites and trading platforms.
Hybrid Brokerage Platform Technology. We utilize several sophisticated proprietary electronic brokerage platforms to distribute prices and offer electronic trade execution to our customers. These platforms include our CreditMatch®, GFI ForexMatch® and EnergyMatch® electronic brokerage platforms. Price data is transmitted over these platforms by our proprietary global private network and by third-party providers that connect to the financial community. Our hybrid brokerage platforms and systems operate on a technology platform and network that emphasizes scalability, performance, adaptability and reliability, and that provides our customers with a variety of means to connect to our brokers and brokerage platforms, including dedicated point-to-point data lines, virtual private networks,
proprietary application programming interfaces and the Internet. We provide customers with proprietary application programming interfaces ("APIs") that automate customer order flow and trade matching. These efforts seek to automate large parts of the trade reporting and settlement process via straight-through processing, thereby reducing errors, risks and costs traditionally associated with post-trade activities.
Post-Trade Technology. Our hybrid brokerage platforms automate previously paper- and telephone-based transaction processing, confirmation and other functions, substantially improving and reducing the cost incurred by many of our customers' back offices and enabling straight-through processing. In addition to our own system, confirmation and trade processing is also available through third-party hubs including Markitwire, Reuters RTNS, ConfirmHub, EFETnet and direct straight-through processing in Financial Information eXchange (FIX) Protocol for various banks. We have electronic connections to most mainstream clearinghouses, including The Depository Trust & Clearing Corporation (through third party clearing firms), Continuous Linked Settlement, Euroclear, Clearstream, LCH Clearnet, Eurex, the CME Group, Inc. ("CME"), Euro CCP and European Multilateral Clearing Facility N.V ("EMCF"). We intend to expand the number of clearinghouses to which we connect in the future.
We further provide data communication and STP connections with our customers' settlement, risk management and compliance operations in order to better serve their needs and to strengthen our relationships with them. STP generally involves the use of technology to automate the processing of financial transactions, from execution to settlement, in order to minimize human error, reduce operational costs and time, and enhance transaction information and reporting.
Risk Management Platforms. GFI maintains a proprietary electronic risk monitoring system to monitor and mitigate market risks, which provides management with daily credit reports in each of our geographic regions that analyze credit concentration and facilitates the regular monitoring of transactions against key risk indicators. In addition, our Kyte subsidiary maintains proprietary risk management platforms which are used to manage risk associated with its customers. These proprietary risk platforms create risk profile reports using algorithms that calculate real time net position reports using information from exchanges and third-party market data providers, such as Reuters. The systems can calculate the net risk of a customer's entire portfolio covering a broad range of products, including cash bonds, futures, options, equities and spot FX.
Systems Architecture. Our systems are implemented as a multi-tier hub and spoke architecture comprised of several components, which provide matching, credit management, market data distribution, position reporting, customer display and customer integration. The private network currently operates from concurrent data centers and hub cities throughout the world acting as distribution points for all private network customers.
In addition to our own network system, we also receive and distribute secure trading information from customers using the services of multiple, major Internet service providers throughout the world. These connections enable us to offer our products and services via the Internet to our global customers.
We employ a technology development philosophy that emphasizes state-of-the-art technology with cost efficiency in both our electronic brokerage platforms, such as CreditMatch®, GFI ForexMatch® EnergyMatch® and GlobalVision® (a product of Trayport®), and our data and analytics products. We take a flexible approach by developing in-house, purchasing or leasing technology products and services and by outsourcing support and maintenance where appropriate to manage our technology expense
more effectively. For each market in which we operate, we seek to provide the optimal mix of electronic and telephonic brokerage.
Market Data and Analytics Products Technology. Our market data and analytics products are developed internally using advanced development methodologies and computer languages. Through years of developing Fenics products, our in-house software development team is experienced in creating simple, intuitive software for use with complex derivative instruments.
Support and Development. At December 31, 2011, we employed a team of 342 computer, telecommunication, network, database, customer support, quality assurance and software development specialists globally. We devote substantial resources to the continuous development and support of our electronic brokerage capabilities, the introduction of new products and services to our customers and the training of our employees. Our software development capabilities allow us to be flexible in our decisions to either purchase or license technology from third parties or to develop it internally.
Disaster Recovery. We have contingency plans in place to protect against major carrier failures, disruption in external services (market data and internet service providers), server failures and power outages. All critical services are connected via redundant and diverse circuits and, where possible, we employ site diversity. Production applications are implemented with a primary and back-up server, and all data centers have uninterruptible power source and generator back-up power. Our servers are backed-up daily, and back-up tapes are sent off-site daily. We have a limited number of reserved "seats" available to relocate key personnel in the event that we were unable to use certain of our offices for an extended period of time. We intend to increase this number of seats, some of which may be shared with other companies, as part of our business continuity plans.
We seek to protect our internally developed and purchased intellectual property through a combination of patent, copyright, trademark, trade secret, contract and fair business practice laws. Our proprietary technology, including our Trayport and Fenics software, is generally licensed to customers under written license agreements. Where appropriate, we also license and incorporate software and technology from third parties that is protected by intellectual property rights belonging to those third parties.
We pursue registration of some of our trademarks in the United States and in other countries. "GFI Group," "GFInet," "Fenics," "CreditMatch," "GFI ForexMatch," "EnergyMatch," "Amerex", "Starsupply", "Trayport" and "Kyte" are registered trademarks in either the United States and/or numerous overseas jurisdictions.
We have filed a number of patent applications to further protect our proprietary technology and innovations, and have received patents for some of those applications. We believe that no single patent or application or group of patents or applications will be of material importance to our business as a whole. Our patents have expiration dates ranging from 2015 to 2028.
Competition in the wholesale brokerage industry is intense. We encounter competition in all aspects of our businesses, including for customers, employees and acquisition candidates.
Inter-dealer Brokers. Our primary competitors with respect to dealer to dealer, or "inter-dealer", OTC brokerage services are currently four firms: ICAP Plc, Tullett Prebon Plc, BGC Partners, Inc (a publicly traded subsidiary of Cantor Fitzgerald) and Compagnie Financière Tradition (which is majority owned by Viel & Cie), all of which are currently publicly traded companies. We also compete, to a lesser extent, with several electronic brokerage platforms and a number of smaller, privately held firms
or consortia that tend to specialize in niche products or specific geographical areas. The current size of the inter-dealer brokerage market is difficult to estimate as there is little objective external data on the industry and several participants are private companies that do not publicly report revenues. Over the past decade, the industry has been characterized by the consolidation of well-established smaller firms into the four firms mentioned above and ourselves. We believe this consolidation has resulted from a number of factors, including: the consolidation of primary institutional dealer customers; pressure to reduce brokerage commissions, particularly in more commoditized products; greater dealer demand for technological capabilities and the need to leverage relatively fixed administrative and regulatory costs.
Historically, the inter-dealer brokerage industry has been characterized by fierce competition for customers and brokers. Significant factors affecting competition in the inter-dealer brokerage industry are the qualities, abilities and relationships of professional personnel, the depth and level of liquidity of the market available from the broker, the quality of the technology used to service and assist in execution on particular markets and the relative prices of services and products offered by the brokers and by competing markets and trading processes.
In time, our business may face growing competition from businesses that provide swaps execution services directed towards non-dealer institutions. Companies such as Bloomberg, TradeWeb and MarketAxess have substantial customer relationships with institutional traders of cash instruments and we believe that they will seek to leverage these relationships to further their business in executing swaps transactions. We have not traditionally served such non-dealer institutions in certain of the swaps products that we broker. Rather, in such products, we have maintained deep relationships with the swaps dealers who are the primary providers of liquidity to such markets. We intend to continue to skillfully serve the primary providers of liquidity in the swaps markets, while complying with all regulations, including the Dodd-Frank Act, that require us to provide impartial access to broader categories of market participants.
Broker-Dealers. In brokering certain cash equities and corporate fixed income products, we face competition from traditional cash product broker-dealers that include large, medium and smaller sized financial service firms.
Exchange and Exempt Commercial Markets. In general, we do not compete directly with the major futures exchanges, such as CME, the Chicago Board Options Exchange, Eurex and Euronext.liffe, and exempt commercial markets like the one operated by IntercontinentalExchange (ICE). These exchanges allow participants to trade standardized futures and options contracts. These contracts, unlike the less commoditized OTC products that we focus on, typically contain more standardized terms, and are typically traded in contracts representing smaller notional amounts. Furthermore, the introduction of such standardized exchange-traded futures and options contracts has, in the past, generally been accompanied by continuing growth in the corresponding OTC derivatives markets. We often cross exchange-traded derivatives as OTC transactions and the trades are then either exchanged for exchange-traded instruments, such as a futures contract, or "given up" for clearing to one of the exchanges mentioned above or a third-party CCP or FCM. It is not clear what impact the Dodd-Frank Act will have on these traditional roles as the rules relating to clearing of OTC derivatives and SEFs are still being issued and their impact is still unknown.
In a growing number of markets and products, however, our hybrid brokerage platforms are competing directly with the execution arms of those same exchanges. Pursuant to the Dodd-Frank Act, futures exchanges are authorized to execute swaps transactions, along with swap execution facilities. Accordingly, we expect that in the near future we will compete to be the primary execution venue for swaps transactions with several futures exchanges, as well as our existing wholesale broker competitors.
We believe that exchanges will continue to seek to leverage their platforms and attempt to grow by introducing products designed to compete with or compliment certain products covered by wholesale brokers in the current OTC marketplace or through acquisitions. Exchanges have also acquired wholesale brokers, such as ICE's acquisition in 2008 of CreditEx, a specialist inter-dealer broker of credit derivative products. Most major exchanges have either begun or announced plans to clear many of the existing OTC financial and derivative products. We generally believe that efforts by exchanges to provide clearing venues for the OTC markets are complementary to our business and we expect that such efforts will enable us to provide our services to a broader customer base.
Software, Analytics and Market Data. Several large market data and information providers, such as Bloomberg and Reuters, compete for a presence on virtually every trading desk in our industry. Some of these entities currently offer varying forms of electronic trading of the types of financial instruments in which we specialize. In addition, these entities are currently competitors to, and in some cases customers of, our data and analytical services. Our Trayport subsidiary competes against several independent providers of advanced financial technology and high-end trading systems. Further, we face competition for certain sales of our data products from our inter-dealer, exchange and wholesale broker competitors and from data and technology vendors, such as Markit, a consortium of major financial institutions. In some cases, we have entered into collaborations or joint venture agreements with these other entities with regard to our software, analytics and market data services in order to create a more robust product, increase our distribution channels or, in some cases, white label products through our respective distribution channels.
Overall, we believe that we may also face future competition from other large computer software companies, market data and technology companies and securities brokerage firms, some of which are currently our customers, as well as from any future strategic alliances, joint ventures or other partnerships created by one or more of our potential or existing competitors.
Certain of our subsidiaries, in the ordinary course of their business, are subject to extensive regulation by government and self-regulatory organizations both in the United States and abroad. As a matter of public policy, these regulatory bodies are responsible for safeguarding the integrity of the securities and other financial markets. These regulations are designed primarily to protect the interests of the investing public generally. They cannot be expected to protect or further the interests of our company or our stockholders and may have the effect of limiting or curtailing our activities, including activities that might be profitable.
U.S. Regulation and Certain Clearing Arrangements. In order to conduct our securities related business in the U.S., GFI Securities LLC, one of our subsidiaries, is registered as a broker-dealer with the SEC, and the State of New York, and is regulated by the Financial Industry Regulatory Authority Inc. ("FINRA"). GFI Securities LLC is subject to regulations and industry standards of practice that cover many aspects of its business, including initial licensing requirements, sales and trading practices, safekeeping of customers' funds and securities, capital structure, record keeping, supervision and the conduct of affiliated persons, including directors, officers and employees. GFI Securities LLC also operates CreditMatch®, an electronic brokerage platform that is regulated pursuant to Regulation ATS under the Exchange Act.
In our futures and commodities related activities, our subsidiaries are also subject to the rules of the CFTC, futures exchanges of which they are members and the National Futures Association ("NFA"), a futures self-regulatory organization. GFI Securities LLC is registered as an introducing broker with the NFA and the CFTC. The NFA and CFTC require their members to fulfill certain obligations, including the filing of quarterly and annual financial reports. Failure to fulfill these obligations in a timely manner can result in disciplinary action against the firm. Certain of our
subsidiaries also operate electronic brokerage platforms that are exempt from CFTC regulation either as an exempt board of trade (GFI ForexMatch® and Fenics®) or as an exempt commercial market (EnergyMatch®).
The SEC, FINRA, CFTC and various other regulatory agencies within the United States have stringent rules and regulations with respect to the maintenance of specific levels of net capital by regulated entities. Generally, a broker-dealer's capital is defined as its net worth plus qualified subordinated debt less deductions for certain types of assets. The Net Capital Rule under the Exchange Act requires that at least a minimum part of a broker-dealer's assets be maintained in a relatively liquid form.
If these net capital rules are changed or expanded, or if there is an unusually large charge against our net capital, our operations that require the intensive use of capital would be limited. A large operating loss or charge against our net capital could adversely affect our ability to expand or even maintain these current levels of business, which could have a material adverse effect on our business and financial condition.
The SEC and FINRA impose rules that require notification when net capital falls below certain predefined criteria. These rules also dictate the ratio of debt to equity in the regulatory capital composition of a broker-dealer, and constrain the ability of a broker-dealer to expand its business under certain circumstances. If a firm fails to maintain the required net capital, it may be subject to suspension or revocation of registration by the applicable regulatory agency, and suspension or expulsion by these regulators could ultimately lead to the firm's liquidation. Additionally, the Net Capital Rule and certain FINRA rules impose requirements that may have the effect of prohibiting a broker-dealer from distributing or withdrawing capital and requiring prior notice to the SEC and FINRA for certain capital withdrawals. At December 31, 2011, GFI Securities LLC was, and currently is, in compliance with the net capital rules and had net capital in excess of the minimum requirements.
We maintain clearing arrangements with selected financial institutions in order to settle our principal transactions and maintain deposits with such institutions in support of those arrangements.
Foreign Regulation and Certain Clearing Arrangements. Our overseas businesses are also subject to extensive regulation by various foreign governments and regulatory bodies. These foreign regulations, particularly in the U.K., are broadly similar to that described above for our U.S. regulated subsidiaries.
In the United Kingdom, the Financial Services Authority ("FSA") regulates GFI Securities Limited and certain of our other subsidiaries. These U.K. regulated subsidiaries are also subject to the European-wide Markets in Financial Instruments Directive ("MiFID"). Each of our subsidiaries subject to MiFID has taken the necessary steps in order to comply with these requirements.
As with those U.S. subsidiaries subject to FINRA rules, the ability of our regulated U.K. subsidiaries to pay dividends or make capital distributions may be impaired due to applicable capital requirements. Our regulated U.K. subsidiaries are subject to "consolidated" prudential regulation, in addition to being subject to prudential regulation on a legal entity basis. Consolidated prudential regulation impacts the regulated entity and its parent holding companies in the U.K, including the regulated entity's ability to pay dividends or distribute capital. We are also subject to the European Union's Capital Requirements Directive ("CRD"). This directive requires us to have an "Internal Capital Adequacy Assessment Process" as set forth in the CRD, which puts the responsibility on firms subject to the directive to ensure they have adequate capital after considering their risks.
Our regulated U.K. subsidiaries are also subject to regulations regarding changes in control similar to those described above for GFI Securities LLC. Under FSA rules, regulated entities must obtain prior approval for any transaction resulting in a change in control of a regulated entity. Under applicable FSA rules, control is broadly defined as a 10% interest in the regulated entity or its parent or otherwise exercising significant influence over the management of the regulated entity. As a result of
these regulations, our future efforts to sell shares or raise additional capital may be delayed or prohibited by the FSA.
In the second quarter of 2011, the Company informed the FSA that the Kyte Group Limited's U.K. consolidated group capital had fallen below the required level at December 31, 2010. The amount of consolidated group capital was corrected and the Company has been in compliance since June 2011. In connection with this matter, the FSA issued a notice under Section 166 of the Financial Services and Markets Act 2000 to appoint a "Skilled Person." The scope of the review to be conducted by such Skilled Person included the effectiveness of the Kyte Group Limited's systems and controls relating to regulatory reporting, the procedures for calculating its capital adequacy requirements and a capital restructuring that the Company completed at the end of the second quarter. In accordance with this, the Company appointed a Skilled Person and they completed their review prior to the end of 2011. The Company has discussed the results of such review with the FSA and has agreed with the FSA to put in place remedial actions to improve certain controls, which we expect to be completed by the end of the first quarter of 2012.
GFI Securities Limited is a member of Euroclear for the purpose of clearing certain debt and equity transactions. This membership requires GFI Securities Limited to deposit collateral or provide a letter of credit to Euroclear so that Euroclear will extend a clearing line to GFI Securities Limited.
The Kyte Group Limited and Kyte Broking Limited maintain execution and clearing relationships with Newedge Group, Bank of America Merrill Lynch, Societe Generale, International and Commercial Bank of China, Deutsche Bank, BGC Brokers and Otkritie Securities in order to provide their clients with direct market access to a number of exchanges and multilateral trading facilities (MTFs). These arrangements require the deposit of collateral to facilitate market access and clearing.
GFI Securities Limited's Dublin branch was established through the exercise of its passport right to open a branch within a European Economic Area state. The establishment of the branch was approved by the FSA and acknowledged by the Irish Financial Services Regulatory Authority ("IFSRA") in Ireland. The branch is subject to all of the conduct of business rules of the IFSRA and is regulated, in part, by the FSA.
In Paris, a branch of GFI Securities Limited was established through the exercise of its passport right to open a branch in a European Economic Area ("EEA") state. The establishment of the branch was approved by the FSA and acknowledged by Banque de France in France. The branch is subject to the conduct of business rules of the Autorite Des Marches Financiers ("AMF") when dealing with resident customers of France and is regulated, in part, by the FSA.
GFI Securities Limited's Tel Aviv branch is registered as a foreign corporation in Israel and is conditionally exempt from the requirement to hold a Securities License in accordance with the Israeli Securities law. The branch is therefore not subject to any capital requirements.
GFI Securities Limited's Dubai branch is registered with the Dubai Financial International Centre and is authorized by the Dubai Financial Services Authority ("DFSA") to provide financial service activities. The branch is subject to the conduct of business rules of the DFSA and has been granted a waiver from prudential regulation by the DFSA.
In Hong Kong, the Securities and Futures Commission ("SFC") regulates our subsidiary, GFI (HK) Securities LLC, as a securities broker. The compliance requirements of the SFC include, among other things, net capital requirements (known as the Financial Resources Rule) and stockholders' equity requirements. The SFC regulates the activities of the officers, directors, employees and other persons affiliated with GFI (HK) Securities LLC and requires the registration of such persons.
GFI (HK) Brokers Ltd. is registered with and regulated by the Hong Kong Monetary Authority ("HKMA"). As part of this registration, GFI (HK) Brokers Ltd. is required to maintain a minimum level of stockholders' equity.
In Tokyo, the Japan Securities Dealers Association ("JSDA") regulates GFI Securities Limited's Japanese branch. The JSDA regulates the activities of the officers, directors, employees and other persons affiliated with the branch. This branch is also subject to certain licensing requirements established by the Financial Instruments and Exchange Law (the "FIEL") in Japan, including maintaining minimum levels of capital and stockholders' equity.
In Singapore, GFI Group PTE Ltd is subject to the compliance requirements of the Monetary Authority of Singapore ("MAS"), which includes, among other things, a stockholders' equity requirement.
In Sydney, our brokerage operations are conducted through a branch of GFI Brokers Limited. GFI Brokers Limited is registered as a foreign corporation in Australia and is conditionally exempt from the requirement to hold an Australian financial services license under the Australian Securities and Investments Commission Corporations Act 2001 in respect of the financial services it provides in Australia. This exemption applies to foreign companies regulated by the FSA in accordance with UK regulatory standards.
In Korea, GFI Korea Money Brokerage Limited is licensed and regulated by the Financial Supervisory Commission to engage in foreign exchange brokerage business, and is subject to certain regulatory requirements under the Foreign Exchange Transaction Act and regulations thereunder. As a licensed foreign exchange brokerage company, GFI Korea Money Brokerage Limited is required to maintain a minimum requirement of paid-in-capital.
In Chile, GFI Brokers (Chile) Agentes De Valores SpA is licensed and regulated by the Superintendencia de Valores y Seguros de Chile. As part of its licensing requirements, GFI Brokers (Chile) is subject to a minimum capital requirement.
In Colombia, GFI Exchange Colombia S.A. and GFI Securities Colombia S. A. are licensed and regulated by the Superintendencia Financiera de Colombia.
At December 31, 2011, all of our subsidiaries that are subject to foreign net capital rules were, and currently are, in compliance with those rules and have net capital in excess of the minimum requirements. We do not believe that we are currently subject to any foreign regulatory inquiries that, if decided adversely, would have any material adverse effect on us and our subsidiaries taken as a whole. As we expand our foreign businesses, we will also become subject to regulation by the governments and regulatory bodies in other countries. The compliance requirements of these different overseer bodies may include, but are not limited to, net capital or stockholders' equity requirements.
Changes in Existing Laws and Rules. Additional legislation and regulations, changes in rules promulgated by the government, regulatory bodies or clearing organizations described above or changes in the interpretation or enforcement of laws and regulations may directly affect the manner of our operation, our net capital requirements or our profitability. In addition, any expansion of our activities into new areas may subject us to additional regulatory requirements that could adversely affect our business, reputation and results of operations.
The government agencies that regulate us continuously review legislative and regulatory initiatives and may adopt new or revised laws and regulations. The financial markets in which we provide our services are currently in the midst of a major global regulatory overhaul, as regulators and legislators in the U.S. and abroad have proposed and, in some instances, already adopted, a slate of regulatory changes that call for, among other things, central clearing of certain derivatives, greater transparency and reporting of derivatives transactions, mandatory trading of certain derivatives transactions on
regulated execution facilities and the required or increased use of electronic trading system technologies. Many of these regulations are not harmonized with those of other jurisdictions and some are in direct conflict. For a more detailed discussion of the changes in regulations in the U.S. and abroad, see Item 1"BusinessRecent Derivative Market Developments."
Exchange Memberships. Through our various subsidiaries, we are members of the following exchanges: Baltic Exchange, BATS, Chicago Mercantile Exchange (non-member firm), Chi-X, Deutsche Boerse (International Securities Exchange, Eurex and Xetra), European Energy Exchange, Intercontinental Exchange (ICE Futures U.S., ICE Canada and ICE Futures Europe), London Metals Exchange (Associate Member), London Stock Exchange, SIX Swiss Exchange, NASDAQ OMX Group (The NASDAQ Stock Market and NASDAQ OMX Europe) NYSE Arca, NYSE Euronext, EDX London, Montreal Exchange ("MX"), Financial Futures Spanish Market ("MEFF"), Italian Derivatives Exchange Market ("IDEM") and Borsa Italiana.
For information regarding working capital items, see "Management's Discussion and Analysis of Financial Condition and Results of OperationsLiquidity and Capital Resources" in Part II, Item 7 of this Form 10-K.
As of December 31, 2011, we employed 2,176 employees. Of these employees, 1,271 are brokerage personnel (consisting of 1,035 brokers and 236 trainees and clerks), 342 are technology and telecommunications specialists and 121 comprise our sales, marketing and customer support professionals. Approximately 34% of our employees are based in the Americas, 52% are based in EMEA and the remaining 14% are based in Asia-Pacific. None of our employees are represented by a labor union. We consider our relationships with our employees to be strong and have not experienced any interruption of operations due to labor disagreements.
Risks Related to Our Business and Competitive Environments.
Economic, political and market factors beyond our control could reduce trading volumes, securities prices and demand for our brokerage services, which could harm our business and our profitability.
Difficult market conditions, economic conditions and geopolitical uncertainties have in the past adversely affected and may in the future adversely affect our business and profitability. Our business and the brokerage and financial services industry in general are directly affected by national and international economic and political conditions, broad trends in business and finance, the level and volatility of interest rates, substantial fluctuations in the volume and price levels of securities transactions and changes in and uncertainty regarding tax and other laws. In each of the three years in the period ended December 31, 2011, over 78% of our revenues were generated by our brokerage operations. As a result, our revenues and profitability are likely to decline significantly during periods of low trading volume in the financial markets in which we offer our services. The financial markets and the global financial services business are, by their nature, risky and volatile and are directly affected by many national and international factors that are beyond our control. Any one of the following factors, among others, may cause a substantial decline in the United States and global financial markets in which we offer our services, resulting in reduced trading volumes. These factors include:
Declines in the volume of trading in the markets in which we operate generally result in lower revenue from our brokerage business. In addition, although less common, some of our brokerage revenues are determined on the basis of the value of transactions or on credit spreads. Therefore, declines in the value of instruments traded in certain market sectors or the tightening of credit spreads could result in lower revenue for our brokerage business. Our profitability would be adversely affected by a decline in revenue because a portion of our costs are fixed. For these reasons, decreases in trading volume or declining prices or credit spreads could have an adverse effect on our business, financial condition or results of operations.
Because competition for the services of brokers is intense, we may not be able to attract and retain the highly skilled brokers we need to support our business or we may be required to incur additional expenses to do so.
We strive to provide high-quality brokerage services that allow us to establish and maintain long-term relationships with our customers. Our ability to continue to provide these services and maintain these relationships depends, in large part, upon our brokers. As a result, we must attract and retain highly qualified brokerage personnel. Competition for the services of brokers is intense, especially for brokers with extensive experience in the specialized markets in which we participate or may seek to enter. If we are unable to hire highly qualified brokers, we may not be able to enter new brokerage markets or develop new products. If we lose one or more of our brokers in a particular market in which we participate, our revenues may decrease and we may lose market share in that particular market.
We may not be successful in our efforts to recruit and retain brokerage personnel. If we fail to attract new personnel or to retain and motivate our current personnel, or if we incur increased costs associated with attracting and retaining personnel (such as sign-on or guaranteed bonuses to attract new personnel or retain existing personnel), our business, financial condition and results of operations may suffer.
In addition, recruitment and retention of qualified staff could result in substantial additional costs. We pursue our rights through litigation when competitors hire our employees who are under contract with us. We are currently involved in legal proceedings with our competitors relating to the recruitment of employees. An adverse settlement or judgment related to these or similar types of claims could have a material adverse effect on our financial condition or results of operations. Regardless of the outcome of these claims, we generally incur significant expense and management time dealing with these claims.
We operate in a rapidly evolving business and technological environment and we must adapt our business and keep up with technological innovation in order to compete effectively.
The pace of change in our industry is extremely rapid. Operating in such a fast paced business environment involves a high degree of risk. Our ability to succeed and compete effectively will depend
on our ability to adapt effectively to these changing market conditions and to keep up with technological innovation.
To remain competitive, we must continue to enhance and improve the responsiveness, functionality, accessibility and other features of our hybrid brokerage systems, network distribution systems and other technologies. The financial services industry is characterized by rapid technological change, changes in use and client requirements and preferences, frequent product and service introductions employing new technologies and the emergence of new and complex regulatory requirements, industry standards and practices that could render our existing practices, technology and systems obsolete. In more liquid markets, development by our competitors of new electronic or hybrid trade execution, STP, affirmation, confirmation or clearing functionalities or products that gain acceptance in the market could give those competitors a "first mover" advantage that may be difficult for us to overcome. Our success will depend, in part, on our ability to:
The development of proprietary brokerage systems and other technology to support our business entails significant technological, financial and business risks. Changes in existing laws and regulations, including those being proposed and implemented under the Dodd-Frank Act, may require us to develop and maintain new brokerage systems, services or functionalities in order to meet the standards set forth in such regulations or as may be required by regulators, such as the CFTC or SEC. Further, the adoption of new Internet, networking or telecommunications technologies may require us to devote substantial resources to modify, adapt and defend our services. We may not successfully implement new technologies or adapt our hybrid brokerage systems and transaction-processing systems to meet our clients' requirements or emerging regulatory or industry standards. We may not be able to respond in a timely manner to changing market conditions or client requirements or successfully defend any challenges to any technology we develop. If we are unable to anticipate and respond to the demand for new services, products and technologies on a timely and cost-effective basis, and to adapt to technological advancements and changing standards, we may be unable to compete effectively, which could negatively affect our business, financial condition or results of operations.
We face substantial competition that could negatively impact our market share and our profitability.
The financial services industry generally, and the wholesale and inter-dealer brokerage businesses in which we are engaged in particular, is very competitive, and we expect competition to continue to intensify in the future. Our current and prospective competitors include:
Some of our competitors offer a wider range of services, have broader name recognition, have greater financial, technical, marketing and other resources than we have and have larger client bases than we do. Some of them may be able to respond more quickly to new or evolving opportunities, technologies and client requirements than we can, and may be able to undertake more extensive marketing activities. Our competitors often seek to hire our brokers, which could result in a loss of brokers by us or in increased costs to retain our brokers. In addition to the competitors described above, our large institutional clients may increase the amount of trading they do directly with each other rather than through us, or they may decrease their trading of certain OTC products in favor of exchange-traded products. In either case, our revenues could be adversely affected. If we are not able to compete successfully in the future, our business, financial condition and results of operations would be adversely affected.
We have experienced intense price competition in our brokerage business and clearing services in recent years. Some competitors may offer brokerage or clearing services to clients at lower prices than we are offering, which may force us to reduce our prices or to lose market share and revenue. In addition, we focus primarily on providing brokerage services in markets for less commoditized financial instruments. As the markets for these instruments become more commoditized, we could lose market share to other inter-dealer brokers, exchanges and electronic multi-dealer brokers who specialize in providing brokerage services in more commoditized markets.
We increasingly compete with exchanges for the execution of trades in certain products. If a financial instrument for which we provide brokerage services becomes listed on an exchange or if an exchange introduces a competing product to the products we broker in the OTC market, the need for our services in relation to that instrument could be significantly reduced and our business, financial condition and results of operations could be adversely affected.
In addition, increased competition has contributed to a decline in clearing revenue per transaction in recent years and may continue to create downward pressure on our clearing revenue per transaction in the future. If the decline in clearing revenue per transaction continues, we may not be able to increase our overall clearing volumes at a comparable rate and our revenues from clearing services would be adversely affected.
Convergence of OTC and exchange-traded markets may impact volumes, liquidity and demand for our services in certain markets.
New regulation in the United States and abroad, including the Dodd-Frank Act, could result in a convergence of the traditional OTC market and the exchange traded market, as certain OTC products are required to and become centrally cleared and traded via an exchange or SEF. As the convergence of the OTC and exchange traded markets occurs, the resulting OTC or SEF market for those products may be less robust, there may be less volume and liquidity in these markets and there may be less demand for our services. If any of this were to occur, our business could be significantly reduced and our business, financial condition and results of operations could be adversely affected.
Consolidation and layoffs in the banking and financial services industries could materially adversely affect our business, financial condition and results of operations.
In recent years, there has been substantial consolidation and convergence among companies in the banking and financial services industries, resulting in increased competition. Continued consolidation or significant layoffs in the financial services industry could result in a decrease in the number of traders for whom we are able to provide brokerage services, which may reduce our trading volumes. In addition, continued consolidation could lead to the exertion of additional pricing pressure by our customers and our competitors, impacting the commissions we generate from our brokerage services. Following the enactment of the Dodd-Frank Act in the United States, many banks have reduced, spun off or are in the process of spinning off their proprietary trading operations due to the increased regulations, costs and uncertainty involved with such operations. It is not yet clear what affect this will have on our transaction volumes, revenues and business or whether we will be able to successfully compete for the business of any new entities created as a result of these spinoffs.
Further, the recent consolidation among exchange firms, and expansion by these firms into derivative and other non-equity trading markets, will increase competition for customer trades and place additional pricing pressure on commissions and spreads. These developments have increased competition from firms with potentially greater access to capital resources than us. Finally, consolidation among our competitors other than exchange firms could result in increased resources and product or service offerings for our competitors. If we are not able to compete successfully in the future, our business, financial condition and results of operations could be materially adversely affected.
If we are unable to continue to identify and exploit new market opportunities, our ability to maintain and grow our business may be adversely affected.
When a new intermediary enters our markets or the markets become more liquid, the resulting competition or increased liquidity may lead to lower commissions. This may result in a decrease in revenue in a particular market even if the volume of trades we handle in that market has increased. As a result, we seek to broker more trades and increase market share in existing markets and to seek out new markets in which we can charge higher commissions. Pursuing this strategy requires significant management attention and broker expense. We may not be able to attract new clients or successfully enter new markets. If we are unable to continue to identify and exploit new market opportunities on a timely and cost-effective basis, our revenues may decline, which would adversely affect our profitability.
Financial or other problems experienced by our clients or third parties could affect the markets in which we provide brokerage services. In addition, any disruption in the key derivatives markets in which we provide services could affect our brokerage revenues.
Problems experienced by third parties could also affect the markets in which we provide brokerage services. In recent years, an increasing number of financial institutions have reported losses or significant exposures tied to write-downs of mortgage and asset backed securities, government securities, structured credit products and other derivative instruments and investments. As a result, there is an increased risk that one of our clients, counterparties or third-party clearing firms could fail, shut down, file for bankruptcy or be unable to satisfy their obligations under certain derivative contracts. The failure of a significant number of counterparties or a counterparty that holds a significant amount of derivatives exposure, or which has significant financial exposure to, or reliance on, the mortgage, asset backed, sovereign debt or related markets, could have a material adverse effect on the trading volume and liquidity in a particular market for which we provide brokerage services or on the broader financial markets. The occurrence of any of these events or failures by our customers or clearing firms could adversely affect our financial condition and results of operations. In addition, in recent years, a significant percentage of our business, directly or indirectly, results from trading activity by hedge funds. Hedge funds typically employ a significant amount of leverage to achieve their results
and, in the past, certain hedge funds have had difficulty managing this leverage, which has resulted in market-wide disruptions. During the economic turmoil of the last few years, many hedge funds have significantly decreased their leverage or have gone out of business. If this deleveraging continues or one or more hedge funds that was a significant participant in a derivatives market experiences problems in the future, that derivatives market could be adversely affected and, accordingly, our brokerage revenues in that market will likely decrease.
Our brokerage, clearing and execution business exposes us to certain client and counterparty credit risks.
We generally provide brokerage services to our clients in the form of either agency or matched principal transactions. In agency transactions, we charge a commission for connecting buyers and sellers and assisting in the negotiation of the price and other material terms of the transaction. After all material terms of a transaction are agreed upon, we identify the buyer and seller to each other and leave them to settle the trade directly. We are exposed to credit risk for commissions we bill to clients for our agency brokerage services. In executing matched principal transactions, we are exposed to the risk that one of the counterparties to a transaction may fail to fulfill its obligations, as described in further detail in the Risk Factor captioned "The securities settlement process exposes us to risks that may impact our liquidity and profitability. In addition, liability for unmatched principal trades could adversely affect our results of operations and statement of financial condition." Our clients may default on their obligations to us arising from either agency or principal transactions due to disputes, bankruptcy, lack of liquidity, operational failure or other reasons. Any losses arising from such defaults could adversely affect our financial condition or results of operations.
We also have credit and counterparty risk in certain situations where we provide clearing and execution services. We provide agency clearing services through our relationships with general clearing member firms and/or exchanges. In these instances, our accounts at such institutions are used, in our name, to provide access to clearing services for our customers.
Credit risk arises from the possibility that we may suffer losses due to the failure of our customers or other counterparties to satisfy their financial obligations to us or in a timely manner. We may be materially and adversely affected in the event of a significant default by our customers or counterparties. Credit risks we face include, among others:
Customers and counterparties that owe us money or securities may default on their obligations to us due to bankruptcy, lack of liquidity, operational failure or other reasons. Our reputation may be damaged if we are associated with a customer or counterparty that defaults, even if we do not have any direct losses from such an event. For further detail see the Risk Factor captioned "The securities settlement process exposes us to risks that may impact our liquidity and profitability. In addition,
liability for unmatched principal trades could adversely affect our results of operations and statement of financial condition."
We have adopted policies and procedures to identify, monitor and manage our credit risk, in both agency and principal transactions, through reporting and control procedures and by monitoring credit standards applicable to our clients. These policies and procedures, however, may not be fully effective. Some of our risk management methods depend upon the evaluation of information regarding markets, clients or other matters that are publicly available or otherwise accessible by us. That information may not, in all cases, be accurate, complete, up-to-date or properly evaluated. If our policies and procedures are not fully effective or we are not always successful in monitoring or evaluating the credit risks to which we are, or may, be exposed, our financial condition or results of operations could be adversely affected. In addition, our insurance policies may not provide coverage for these risks.
In addition, concerns about, or a default by, one institution could lead to significant liquidity problems, losses or defaults by other institutions, which in turn could adversely affect us. We may also be adversely affected if settlement, clearing or payment systems become unavailable, fail or are subject to systemic delays for any reason outside our control.
In certain instances, we may extend credit to our clearing customers for margin requirements, which subjects us to credit risks and if we are unable to liquidate a customer's securities when the margin collateral becomes insufficient, we may suffer a loss.
In certain instances, we may provide credit for margin requirements to customers; therefore, we are subject to risks inherent in extending credit. Our credit risks include the risk that the value of the collateral we hold could fall below the amount of a customer's indebtedness. This risk can be amplified in any situation where the market for the underlying security is rapidly declining. Agreements with customers that have margin accounts permit us to liquidate their securities in the event that the amount of margin collateral becomes insufficient. Despite those agreements and our risk management policies with respect to margin, we may be unable to liquidate the customers' securities for various reasons, or at a price sufficient to cover any deficiency in a customer's account. If we were unable to liquidate a position at a price sufficient to cover any deficiency or if a customer was unable to post additional margin, we could suffer a loss.
Certain of our clearing customers may choose to obtain a direct relationship with a clearing member, an exchange or a clearinghouse as their operations grow, in which case, we would lose the revenues generated by such customers.
We market our clearing services to our existing customers on the strength of our relationship with certain clearing members and exchanges and on our ability to perform related back-office functions at a lower cost than the customers could perform these functions themselves. As our customers' operations grow, they may consider the option of obtaining a direct relationship with a clearing member, clearinghouse or exchange themselves in an effort to save costs. If our customers choose to obtain their clearing services directly, we would lose their revenue and our business could be adversely affected.
Risks Related to Our Operations.
We operate in a highly regulated industry and we may face restrictions with respect to the way we conduct certain of our operations.
Our business is subject to increasingly extensive government and other regulation and our relationships with our clients may subject us to increasing regulatory scrutiny. These regulations are designed to protect public interests generally rather than our stockholders. The SEC, FINRA, CFTC and other agencies extensively regulate the United States financial services industry, including much of our operations in the United States. Some of our international operations are subject to similar
regulations in their respective jurisdictions, including regulations overseen by the FSA in the United Kingdom, the AMF in France, the SFC in Hong Kong, the MAS in Singapore, the JSDA in Japan, the Ministry of Finance and Economy in Korea and the SVS in Chile. These regulatory bodies are responsible for safeguarding the integrity of the securities and other financial markets and protecting the interests of investors in those markets. Most aspects of our business are subject to extensive regulation, including:
If we fail to comply with any of these laws, rules or regulations, we may be subject to censure, fines, cease-and-desist orders, suspension of business, suspensions of personnel or other sanctions, including revocation of our registrations with FINRA, withdrawal of our authorizations from the FSA or revocation of our registrations with other similar international agencies to whose regulation we are subject. For example, several of GFI Securities LLC's equity and corporate bond brokerage desks have experienced issues relating to reporting trades to FINRA on a timely basis, which is required by FINRA rules. This subsidiary has also paid fines for trade reporting in recent years and is currently being reviewed by FINRA for similar issues relating to trade reporting. For more details on recent disciplinary proceedings, see "Item 3Legal Proceedings."
Our authority to operate as a broker in a jurisdiction is dependent on continued registration or authorization in that jurisdiction or the maintenance of a proper exemption from such registration or authorization. Our ability to comply with all applicable laws and rules is largely dependent on our compliance, credit approval, audit and reporting systems and procedures, as well as our ability to attract and retain qualified compliance, credit approval, audit and risk management personnel. Our systems and procedures may not be sufficiently effective to prevent a violation of all applicable rules and regulations. In addition, the growth and expansion of our business may create additional strain on our compliance systems and procedures and has resulted, and we expect will continue to result, in increased costs to maintain and improve these systems.
In addition, because our industry is heavily regulated, regulatory approval may be required in order to continue or expand our business activities and we may not be able to obtain the necessary regulatory approvals. Even if approvals are obtained, they may impose restrictions on our business or we may not be able to continue to comply with the terms of the approvals or applicable regulations. The implementation of unfavorable regulations or unfavorable interpretations of existing regulations by courts or regulatory bodies could require us to incur significant compliance costs or cause the development or continuation of business activities in affected markets to become impractical. For a further description of the regulations which may limit our activities, see "Item 1BusinessRegulation."
Some of our subsidiaries are subject to regulations regarding changes in control of their ownership. These regulations generally provide that regulatory approval must be obtained in connection with any
transaction resulting in a change in control of the subsidiary, which may include changes in control of GFI Group Inc. As a result of these regulations, our future efforts to sell shares or raise additional capital may be delayed or prohibited in circumstances in which such a transaction would give rise to a change in control as defined by the applicable regulatory body.
Broad changes in laws or regulations or in the application of such laws and regulations may have an adverse effect on our ability to conduct our business.
The financial services industry, in general, is heavily regulated. Proposals for legislation further regulating the financial services industry are continually being introduced in the United States Congress, in state legislatures and by foreign governments. The government agencies that regulate us continuously review legislative and regulatory initiatives and may adopt new or revised laws and regulations and have broad powers to investigate and enforce compliance and punish noncompliance with their rules, regulations and industry standards of practice. In light of recent conditions in the United States financial markets and economy, regulators have increased their focus on the regulation of the financial services industry. We are unable to predict whether any of these proposals will be implemented or in what form, or whether any additional or similar changes to statutes or regulations, including the interpretation or implementation thereof, will occur in the future. Any such action could affect us in substantial and unpredictable ways and could have an adverse effect on our business, financial condition and results of operations.
We are also affected by the policies adopted by the Federal Reserve and international central banking authorities, which may directly impact our cost of funds for capital raising and investment activities and may impact the value of financial instruments we hold. In addition, such changes in monetary policy may affect the credit quality of our customers. Changes in domestic and international monetary policy are beyond our control and are difficult to predict.
Additionally, governments and regulators in both the United States and Europe have called for increased regulation and transparency in the OTC markets. As a result, the Dodd-Frank Act was passed in the United States in July 2010 and regulators in Europe are currently considering similar legislation. For a detailed description of the Dodd-Frank Act, see the Risk Factor captioned "Failure to qualify as a swap execution facility could significantly impact our business, financial condition and results of operations. Even if we qualify as a swap execution facility, we will incur significant additional costs, our revenues may be lower than in the past and our financial condition and results of operations may be adversely affected."
In September 2010, the European Commission released a draft proposal referred to as the European Market Infrastructure Regulation ("EMIR") requiring that information on OTC derivative contracts should be reported to trade repositories and be accessible to supervisory authorities, that some transaction and price related information should be made available to all market participants and that standard OTC derivative contracts be cleared through central counterparties ("CCPs"). EMIR was approved by the European Parliament in February 2012 and it is expected that the proposed rules will be operational by year-end 2012.
It is difficult to predict the effect these new laws and regulations will have on our business, but they may have an adverse affect on our operations or our ability to maintain our position as a provider of execution and brokerage services for many of the OTC products for which we have traditionally acted as an intermediary.
Failure to qualify as a swap execution facility could significantly impact our business, financial condition and results of operations. Even if we qualify as a swap execution facility, we will incur significant additional costs, our revenues may be lower than in the past and our financial condition and results of operations may be adversely affected.
The Dodd-Frank Act created a new type of regulated entity known as a swap execution facility (referred to herein as a SEF) and mandated that certain cleared swaps (subject to an exemption from the clearing requirement) trade on either an exchange or SEF. The list of swaps that will be required to be cleared and therefore executed through a SEF is not yet final, but is expected to encompass a vast number of swaps that have been traditionally executed OTC by wholesale brokers such as ourselves. As with other parts of the Dodd-Frank Act, many of the details of the new regulatory regime relating to swaps are left to the CFTC and SEC to determine through rulemaking. Subject to such rulemaking, we currently expect to establish and operate a swap execution facility and a security-based swap execution facility.
The CFTC and SEC have each issued proposed rules relating to the requirements for registering and operating as a SEF. We are in the process of preparing for compliance with the proposed rules. However, many of these rules are not yet final and are still subject to revision and therefore, the impact of the rules is not able to be predicted. The proposed rules relating to SEFs would require, among other things, that an entity would have to comply with certain core principles to maintain registration as a SEF. These principles generally relate to trading and product requirements, compliance and audit-trail obligations, governance and disciplinary requirements, operational capabilities, surveillance obligations and financial information and resource requirements. In addition, SEFs will be required to maintain certain trading systems that meet the minimum functionality requirements set by the CFTC and SEC for trading in certain OTC derivatives that are required to be cleared.
There will be significant costs to prepare for and to comply with these ongoing regulatory requirements. We will incur increased legal fees, personnel expenses and other costs as we work to analyze and implement the necessary legal structure for registration. There will also be significant costs related to the development, operation and enhancement of our technology relating to trade execution, trade reporting, surveillance, compliance and back-up and disaster recovery plans designed to meet the requirements of the regulators.
In addition, it is not clear at this point what the impact of these rules and regulations will be on the markets in which we currently provide our services. Following the adoption of the Dodd-Frank Act and related rules, the markets for cleared and non-cleared swaps may be less robust, there may be less volume and liquidity in these markets and there may be less demand for our services. There may also be a preference of market participants to trade certain swaps on an exchange, rather than a SEF. Certain banks and other institutions will be limited in their conduct of proprietary trading and will be further limited or prohibited from trading in certain derivatives. The new rules, including the restrictions on the trading activities for certain banks and large institutions, could materially impact transaction volumes and liquidity in these markets and our revenues, financial condition and business would be adversely impacted as a result.
If we fail to qualify as a SEF under any of these proposed rules, we will be unable to maintain our position as a provider of execution and brokerage services in the markets for many of the OTC products for which we have traditionally acted as an intermediary. This would have a broad impact on our business and could have a material adverse affect on our financial condition and results of operations.
Our regulated subsidiaries are subject to risks associated with net capital requirements, and we may not be able to engage in operations that require significant capital.
Many aspects of our business are subject to significant capital requirements. The SEC, FINRA, FSA, JSDA and various other domestic and international regulatory agencies have stringent rules and regulations with respect to the maintenance of specific levels of net capital by broker-dealers. In addition, there may be capital requirements for SEFs and swap dealers, which will be established by the CFTC and the SEC.
Generally, a broker-dealer's net capital is defined as its net worth plus qualified subordinated debt less deductions for certain types of assets. While we expect to continue to maintain levels of capital in excess of regulatory minimums, there can be no assurance that this will be the case in the future. If we fail to maintain the required capital levels, we will be required to suspend our broker-dealer operations during any period in which we are not in compliance with capital requirements, and may be subject to suspension or revocation of registration by the SEC and FINRA or withdrawal of authorization or other disciplinary action from domestic and international regulators, which would have a material adverse effect on our business. If these net capital rules are changed or expanded, or if there is an unusually large charge against net capital, operations that require the intensive use of capital would be limited. Also, our ability to withdraw capital from our regulated subsidiaries is subject to restrictions, which in turn could limit our ability to pay dividends, repay debt or purchase shares of our common stock. A large operating loss or charge against net capital could adversely affect our ability to expand or even maintain our present levels of business, which could have a material adverse effect on our business. In addition, we may become subject to net capital requirements in other foreign jurisdictions in which we currently operate or which we may enter.
In addition, we are required to maintain capital with our clearing firms, prime brokers and futures commission merchants and at clearing organizations of which we are a member. The amount of capital to be maintained is dependent on a number of factors, including the rules established by the clearing organization, the types of products to be cleared and the volume and size of positions to be cleared. If we fail to maintain the capital required by these clearing organizations and firms, our ability to clear through these clearing organizations and firms may be impaired, which may adversely affect our ability to process trades.
We cannot predict our future capital needs or our ability to obtain additional financing. For a further discussion of our net capital requirements, see "Item 1BusinessRegulation" and Note 20 to the Consolidated Financial Statements.
Our risk management policies might not be effective, which could harm our business.
To manage the significant risks inherent in our business, we must maintain effective policies, procedures and systems that enable us to identify, monitor and control our exposure to financial, market, credit, legal, reputational and operational risks. For a description of our risk management approach, see "Item 7A. Quantitative and Qualitative Disclosure About Market Risk." This risk management function requires, among other things, that we properly record and verify many thousands of transactions and events each day, and that we continuously monitor and evaluate the size and nature of our or our clients' positions and the associated risks. In light of the high volume of transactions, it is impossible for us to review and assess every single transaction or to monitor at every moment in time our or our customers' positions and the associated risks.
We must rely upon our analysis of information regarding markets, personnel, clients or other matters that is publicly available or otherwise accessible to us. That information may not in all cases be accurate, complete, up-to-date or properly analyzed. Furthermore, we rely on a combination of technical and human controls and supervision that are subject to error and potential failure, the challenges of which are exacerbated by the 24-hour-a-day, global nature of our business.
Our risk-management methods are based on internally developed controls, observed historical market behavior and what we believe to be industry practices. However, our methods may not adequately prevent future losses, particularly as they may relate to extreme market movements or events for which little or no historical precedent exists or our risk management efforts may be insufficient. Thus, our risk-management methods may prove to be ineffective because of their design, their implementation or the lack of adequate, accurate or timely information. Our risk management methods may also fail to identify a risk or understand a risk that might result in losses. If our risk-management policies and efforts are ineffective, we could suffer losses that could have a material adverse effect on our financial condition or operating results. Additionally, we could be subject to litigation, particularly from our clients, and sanctions or fines from regulators.
The securities settlement process exposes us to risks that may impact our liquidity and profitability. In addition, liability for unmatched principal trades could adversely affect our results of operations and statement of financial condition.
Through our subsidiaries, we provide brokerage services by executing transactions for our clients. A significant number of these transactions are "matched principal transactions" in which we act as a "middleman" by serving as a counterparty to both a buyer and a seller in matching reciprocal back-to-back trades. These transactions, which generally involve cash equities and bonds, are then settled through clearing institutions with which we have a contractual relationship.
In executing matched principal transactions, we are exposed to the risk that one of the counterparties to a transaction may fail to fulfill its obligations, either because it is not matched immediately or, even if matched, one party fails to deliver the cash or securities it is obligated to deliver. Our focus on less commoditized markets exacerbates this risk for us because transactions in these markets tend to be more likely not to settle on a timely basis. Adverse movements in the prices of securities that are the subject of these transactions can increase our risk. In addition, widespread technological or communication failures, as well as actual or perceived credit difficulties or the insolvency of one or more large or visible market participants, could cause market-wide credit difficulties or other market disruptions. These failures, difficulties or disruptions could result in a large number of market participants not settling transactions or otherwise not performing their obligations.
We are subject to financing risk in these circumstances because if a transaction does not settle on a timely basis, the resulting unmatched position may need to be financed, either directly by us or through one of our clearing organizations at our expense. These charges may be recoverable from the failing counterparty, but sometimes are not. Finally, in instances where the unmatched position or failure to deliver is prolonged or widespread due to rapid or widespread declines in liquidity for an instrument, there may also be regulatory capital charges required to be taken by us, which depending on their size and duration, could limit our business flexibility or even force the curtailment of those portions of our business requiring higher levels of capital.
In the process of executing matched principal transactions, miscommunications and other errors by our clients or us can arise whereby a transaction is not completed with one or more counterparties to the transaction, leaving us with either a long or short unmatched position. These unmatched positions are referred to as "out trades," and they create a potential liability for our subsidiary involved in the trade. If an out trade is promptly discovered and there is a prompt disposition of the unmatched position, the risk to us is usually limited. If the discovery of an out trade is delayed, the risk is heightened by the increased possibility of intervening market movements prior to disposition. Although out trades usually become known at the time of, or later on the day of, the trade, it is possible that they may not be discovered until later in the settlement process. When out trades are discovered our policy is generally to have the unmatched position disposed of promptly (usually on the same day and generally within three days), whether or not this disposition would result in a loss to us. The occurrence of out trades generally rises with increases in the volatility of the market and, depending on their
number and amount, such out trades have the potential to have a material adverse effect on our financial condition and results of operations. In addition, the use of our electronic brokerage platforms for products that we broker on a matched principal basis, such as CreditMatch®, can present these risks because of the potential for erroneous entries by our clients or brokers coupled with the potential that such errors will not be discovered promptly.
We are exposed to market risk from principal transactions entered into by some of our desks.
We generally execute orders on a matched principal basis by entering into one side of a customer trade and entering into an offsetting trade with another party relatively quickly (often within minutes and generally on the same trading day). However, we may take unmatched positions for our own account primarily to facilitate the execution of existing customer orders or in anticipation that future customer orders will become available to fill the other side of the transaction. While we seek to minimize our exposure to market risk by entering into offsetting trades or a hedging transaction relatively quickly (often within minutes and generally on the same trading day), we may not always enter into an offsetting trade on the same trading day and any hedging transaction we may enter into may not fully offset our exposure. Therefore, although any unmatched positions are intended to be held short term, we may not entirely offset market risk and may be exposed to market risk for several days or more or to a partial extent or both. Our exposure varies based on the size of the overall positions, the terms and liquidity of the instruments brokered, and the amount of time the positions are held before we dispose of the position.
Although the significant majority of our principal trading is done on a "matched principal" basis, we have authorized a limited number of our desks to enter into principal investing transactions in which we commit our capital within predefined limits, either to facilitate customer trading activities or to engage in principal trading for our own account. These principal positions may ultimately be matched against a customer order or through a market intermediary, either in the short term (such as the same trading day) or we may hold these positions for several days or more. The number and size of these transactions may affect our results of operations in a given period and we may also incur losses from these trading activities due to market fluctuations and volatility from quarter to quarter. To the extent that we have long positions in any of those markets, a downturn in the value of those positions could result in losses from a decline in the value of those long positions. Conversely, to the extent that we have sold assets we do not own (i.e., have short positions) in any of those markets, an upturn in those markets could expose us to significant losses as we attempt to cover our short positions by acquiring assets in a rising market. In addition, in the event that one of our desks enters into principal transactions that exceed their authorized limit and we are unable to dispose of the position promptly, we could suffer losses that could have a material adverse effect on our financial condition or operating results.
Due to the factors described above, including the nature of the position and access to the market on which it trades, we may not be able to match a position or effectively hedge our exposure and often may hold a position overnight or longer that has not been hedged. To the extent these principal positions are not disposed of intra-day, we mark these positions to market. Adverse movements in the securities underlying these positions or a downturn or disruption in the markets for these positions could result in a substantial loss. In addition, any principal gains and losses resulting from these positions could on occasion have a disproportionate positive or negative effect, on our financial condition and results of operations for any particular reporting period.
We have equity investments or profit sharing interests in entities whose primary business is proprietary trading. These investments could expose us to losses that would adversely affect our net income and the value of our assets.
We have equity investments or profit sharing interests in entities whose primary business is proprietary trading. The accounting treatment applied for these investments varies depending on a number of factors, including, but not limited to, our percentage ownership or profit share and whether we have any influence or control over the relevant entity. Under certain accounting standards, any losses experienced by these entities on their investment activities would adversely impact our net income and the value of these assets. In addition, if these entities were to fail and cease operations, we could lose the entire value of our investment and the stream of any shared profits from trading.
Our investments in expanding our brokerage and clearing services, hybrid brokerage systems and market data and analytics services may not produce substantial revenue or profit.
We have made, and expect to continue to make, significant investments in our brokerage, clearing and market data and analytics services, including investments in personnel, technology and infrastructure, in order to pursue new growth opportunities. With respect to our brokerage services and hybrid brokerage systems, we may not receive significant revenue and profit from the development of a new brokerage desk or hybrid brokerage system or the revenue we do receive may not be sufficient to cover the start-up costs of the new desk or the substantial development expenses associated with creating a new hybrid brokerage system. Even when our personnel hires and systems are ultimately successful, there is typically a transition period before these hires or systems become profitable or increase productivity. In some instances, our clients may determine that they do not need or prefer a hybrid brokerage system and the period before the system is successfully developed, introduced and adopted may extend over many months or years. The successful introduction of hybrid brokerage systems in one market or country does not ensure that the same system will be used or favored by clients in similar markets or other countries. Our continued expansion of brokerage personnel and systems to support new growth opportunities results in ongoing transition periods that could adversely affect the levels of our compensation and expense as a percentage of brokerage revenue.
With respect to our investment in clearing, settlement and back-office services, we may not produce significant revenues or profits. In addition, any revenues we do receive may not be sufficient to cover our invested capital or start-up costs. With respect to these services, we may incur significant costs developing and maintaining systems for back-office, risk management and exchange and clearing connections with relevant exchanges and clearing firms. In addition, this business may involve significant management effort to expand. If we are unable to generate sufficient revenue to cover the fixed costs associated with this business, our financial condition or results of operations could be adversely affected.
With respect to our market data and analytics services, we may incur substantial development, sales and marketing expenses and expend significant management effort to create a new product or service. Even after incurring these costs, we ultimately may not sell any or sell only small amounts of these products or services. Consequently, if revenue does not increase in a timely fashion as a result of these expansion and development initiatives, the up-front costs associated with them may exceed the related revenue and reduce our working capital and income.
If we are unable to manage the risks of international operations effectively, our business could be adversely affected.
We provide services and products to clients globally through offices in Europe, the Middle East, Africa, South America and Asia and we may seek to further expand our operations in the future. On a geographic basis, approximately 59% and 54% of our total revenues for the years ended December 31,
2011 and 2010, respectively, were generated by our operations in Europe, the Middle East and Africa (EMEA), 31% and 36%, respectively, were generated by our operations in the Americas, which include operations in South America, and 10% and 10%, respectively, were generated by our operations in the Asia-Pacific region. There are certain additional risks inherent in doing business in international markets, particularly in the regulated brokerage industry. These risks include:
Our international operations also expose us to the risk of fluctuations in currency exchange rates. For example, a substantial portion of our revenue from our London office, our largest international office, is received in Euros and U.S. Dollars, whereas many of our expenses from our London operations are payable in British Pounds. Our risk management strategies relating to exchange rates may not prevent us from suffering losses that would adversely affect our financial condition or results of operations.
Our international operations are also subject to the political, legal and economic risks associated with politically unstable and less developed regions of the world, including the risk of war and other international conflicts and actions by governmental authorities, insurgent groups, terrorists and others. In addition, we are required to comply with the laws and regulations of foreign governmental and regulatory authorities of each country in which we conduct business. These may include laws, rules and regulations, including registration requirements. For example, in Europe, the European Commission published a formal proposal for the regulation of OTC derivatives, central clearing parties and trade repositories in September 2010, which is referred to as the European Market Infrastructure Regulation ("EMIR"). EMIR, which is currently in the approval phase with the European Counsel and European Parliament, proposes central clearing and transparent reporting requirements for OTC derivatives and is expected to be in place by year-end 2012. Our compliance with these laws and regulations may be difficult and time consuming and may require significant expenditures and personnel requirements, and our failure to be in compliance would subject us to legal and regulatory liabilities. We may also experience difficulty in managing our international operations because of, among other things, competitive conditions overseas, established domestic markets, language and cultural differences and economic or political instability. Any of these factors could have a material adverse effect on the success of our international operations or limit our ability to grow our international operations and, consequently, on our business, financial condition and operating results.
We may be exposed to risk from our operations in emerging market countries, including counterparty risks exposure.
Our businesses and operations are increasingly expanding into new regions, including emerging markets, and we expect this trend to continue. We have entered into an increasing number of matched principal transactions with counterparties domiciled in countries in the Middle East, Latin America, Eastern Europe and Asia. Recent events in the Middle East have created instability in the region, particularly with respect to certain sovereign entities. Transactions with these counterparties are generally in instruments or contracts of sovereign or corporate issuers located in the same country or region as the counterparty. This exposes us to a higher degree of sovereign or convertibility risk than in more stable or developed countries. In addition, these risks may be correlated risks. A correlated risk arises when the counterparty's inability to meet its obligations will also correspond to a decline in the value of the instrument traded. In the case of a sovereign convertibility event or outright default, the
counterparty to the trade may be unable to pay or transfer payment of an instrument purchased out of the country when the value of the instrument has declined due to the default or convertibility event. Various emerging market countries have experienced severe economic and financial disruptions, including significant devaluations of their currencies, defaults or threatened defaults on sovereign debt, capital and currency exchange controls, and low or negative growth rates in their economies. These conditions could have an adverse impact on our businesses and increased volatility in financial markets generally. Through our risk management procedures, we monitor the creditworthiness of emerging countries and counterparties on an ongoing basis and when the risk of inconvertibility or sovereign default is deemed to be too great, correlated transactions or all transactions may be restricted or suspended. However, there can be no assurance that our procedures will be effective in controlling these risks, which, if not successfully controlled, could result in a loss that could have a material adverse effect on our financial condition and operating results.
We may have difficulty managing our expanding operations effectively.
We have significantly expanded our business activities and operations over the last several years, which have placed, and are expected to continue to place, a significant strain on our management and resources. Continued expansion into new markets and regions will require continued investment in management and other personnel, facilities, information technology infrastructure, financial and management systems and controls and regulatory compliance controls. The expansion of our international operations, particularly our Asia-Pacific and South American operations, involves additional challenges that we may not be able to meet, such as the difficulty in effectively managing and staffing these operations and complying with the increased regulatory requirements associated with operating in new jurisdictions.
We may not be successful in implementing all of the processes that are necessary to support these initiatives, which could result in our expenses increasing faster than our revenues, causing our operating margins and profitability to be adversely affected, or it could result in us having insufficient controls in our operations for a period of time. Accordingly, this expansion, if not properly managed, could result in a loss that could have a material adverse effect on our financial condition and operating results.
In the event of employee misconduct or error, our business may be harmed.
Employee misconduct or error could subject us to legal liability, financial losses and regulatory sanctions and could seriously harm our reputation and negatively affect our business. Misconduct by employees could include engaging in improper or unauthorized transactions or activities, failing to properly supervise other employees or improperly using confidential information. Employee errors, including mistakes in executing, recording or processing transactions for customers, could cause us to enter into transactions that clients may disavow and refuse to settle, which could expose us to the risk of material losses even if the errors are detected and the transactions are unwound or reversed. If our clients are not able to settle their transactions on a timely basis, the time in which employee errors are detected may be increased and our risk of material loss could be increased. The risk of employee error or miscommunication may be greater for products that are new or have non-standardized terms. It is not always possible to deter employee misconduct or error, and the precautions we take to detect and prevent this activity may not be effective in all cases.
Brokerage services involve substantial risks of liability, and we therefore may become subject to risks of litigation.
Many aspects of our business, and the businesses of our clients, involve substantial risks of liability. Dissatisfied clients may make claims regarding quality of trade execution, improperly settled trades or mismanagement against us. We may become subject to these claims as the result of failures or malfunctions of our trading systems or other brokerage services provided by us, and third parties may
seek recourse against us. We attempt to limit our liability to our customers through the use of written or "click-through" agreements, but we do not have such agreements with many of our clients. We could incur significant legal expenses defending claims, even those without merit. An adverse resolution of any lawsuit or claim against us could result in our obligation to pay substantial damages.
If we acquire other companies or businesses, or if we hire new brokerage personnel, we may have difficulty integrating their operations.
To achieve our strategic objectives, we have acquired or invested in, and in the future may seek to acquire or invest in, other companies and businesses. We also may seek to hire brokers for new or existing brokerage desks. These acquisitions or new hires may be necessary in order for us to enter into or develop new product areas or trading systems. Acquisitions and new hires entail numerous risks, including:
In addition, we expect to face competition for acquisition targets and/or joint venture partners, which may limit the number of acquisitions and growth opportunities and could lead to higher acquisition prices. We may not be able to successfully identify, acquire or manage profitably additional businesses or integrate businesses without substantial costs, delays or other operational or financial difficulties.
If we fail to manage these risks as we make acquisitions or make new hires, our profitability may be adversely affected, and we may never realize the anticipated benefits of the acquisitions or hires. In addition, entering into new businesses may require prior approval from regulators. Our ability to obtain timely approval from applicable regulators may hinder our ability to successfully enter new businesses.
Seasonal fluctuations in trading may cause our quarterly operating results to fluctuate.
In the past, our business has experienced seasonal fluctuations, reflecting reduced trading activity during summer months, particularly in August. We also generally experience reduced activity in December due to seasonal holidays. As a result, our quarterly operating results may not be indicative
of the results we expect for the full year. Our operating results may also fluctuate quarter to quarter due to a variety of factors beyond our control, such as conditions in the global financial markets, terrorism, war and other economic and political events. Furthermore, we may experience reduced revenues in a quarter due to a decrease in the number of business days in that quarter compared to prior years.
Computer systems failures, capacity constraints, breaches of security and natural or other disasters could prevent us from operating parts of our business or otherwise damage our reputation or business.
We internally support and maintain many of our computer systems, brokerage platforms and networks. Our failure to monitor, maintain or, if necessary, replace these systems, brokerage platforms and networks in a timely and cost-effective manner could have a material adverse effect on our ability to conduct our operations.
We also rely and expect to continue to rely on third parties to supply and maintain various computer systems, trading platforms and communications systems, such as telephone companies, internet service providers, data processors, clearing organizations, software and hardware vendors and back-up services. Our systems, or those of our third party providers, may fail or operate slowly, causing one or more of the following:
We may experience systems or office failures from power or telecommunications outages, acts of God, war, terrorism, human error, natural disasters, fire, sabotage, hardware or software malfunctions or defects, computer viruses, intentional acts of vandalism or similar events. Additionally, our business continuity or disaster recovery plans and related systems may not be effective to deal with such events and the failure of such plans or systems may have a material adverse effect on our business. Any system failure that causes an interruption in service or decreases the responsiveness of our service, including failures caused by client error or misuse of our systems, could damage our reputation, business and brand name. In addition, if security measures contained in our systems are breached as a result of third-party actions, employee error, malfeasance, or otherwise, our reputation may be damaged and our business could suffer.
If systems maintained by us or third parties malfunction, our clients or other third parties may seek recourse against us. We could incur significant legal expenses defending these claims, even those which we may believe to be without merit. An adverse resolution of any lawsuits or claims against us could result in our obligation to pay substantial damages and could have a material adverse effect on our financial condition or results of operations.
If one or more of our offices were destroyed, damaged or unusable for a period of time we may suffer a loss of revenue, experience business interruption in that region or incur expenses to relocate or
repair the affected office to the extent not covered by insurance. If any of these were to occur, it could have a material adverse effect on our financial condition or results of operations.
We may not be able to protect our intellectual property rights or may be prevented from using intellectual property necessary for our business.
Our business depends in part on whether we are able to maintain the proprietary aspects of our technology and to operate without infringing on the proprietary rights of others. We rely primarily on trade secret, contract, copyright, trademark and patent law to protect our proprietary technology. However, these protections may not be adequate to prevent third parties from copying or otherwise obtaining and using our proprietary technology without authorization or otherwise infringing on our rights.
We may also face claims of infringement that could interfere with our ability to use technology that is material to our business operations. We may face limitations or restrictions on the distribution of some of the market data generated by our brokerage desks, which may limit the comprehensiveness and quality of the data we are able to distribute or sell.
In addition, in the past several years, there has been proliferation of so-called "business method patents" applicable to the computer and financial services industries. There has also been a substantial increase in the number of such patent applications filed. Under current law, United States patent applications remain secret for 18 months and may, depending upon where else such applications are filed, remain secret until a patent is issued. In light of these factors, it is not economically practicable to determine in advance whether our products or services may infringe the present or future patent rights of others. In addition, although we take steps to protect our technology, we may not be able to protect our technology from disclosure or from other developing technologies that are similar or superior to our technology. Any failure to protect our intellectual property rights could materially and adversely affect our business and financial condition.
If we are unable to adequately protect our intellectual property rights or if we infringe on the rights of others, we could become involved in costly disputes and may be required to pay royalties or enter into license agreements with third parties.
In the future, we may have to rely on litigation to enforce our intellectual property rights, protect our trade secrets, determine the validity and scope of the proprietary rights of others or defend against claims of infringement or invalidity. This litigation could result from claims that we are violating the rights of others or may be necessary to enforce our own rights. Any such litigation would be time consuming and expensive to defend or resolve and would result in the diversion of the resources and attention of management, and the outcome of any such litigation cannot be accurately predicted. Any adverse determination in such litigation could subject us to significant liabilities or require us to pay royalties or enter into license agreements with third parties, which we may not be able to obtain on terms acceptable to us or at all.
We depend on third-party software licenses. The loss of any of our key licenses could adversely affect our ability to provide our brokerage services.
We license software from third parties, some of which is integral to our execution services, hybrid brokerage systems and our business. These licenses are generally terminable if we breach our obligations under the licenses or if the licensor gives us notice in advance of the termination. If any of these relationships were terminated, or if any of these third parties were to cease doing business, we may be forced to spend significant time and money to replace the licensed software. These replacements may not be available on reasonable terms, if at all. A termination of any of these relationships could have a material adverse effect on our financial condition and results of operations.
Risks Related to Our Liquidity and Financing Needs
Our liquidity and financial condition could be adversely affected by United States and international markets and economic conditions.
Liquidity is essential to our business and is of particular importance to our trading business. Any perceived liquidity issues may affect our clients' and counterparties' willingness to engage in brokerage transactions with us. In addition, our business is dependent upon the availability of adequate regulatory and clearing capital. Clearing capital is the amount of cash, guarantees or similar collateral that we must provide or deposit with our third party clearing organizations in support of our obligations under our contractual clearing arrangements with these organizations. Historically, these needs have been satisfied from internally generated funds, investments from our stockholders and lines of credit made available by commercial banking institutions.
Our liquidity could be impaired due to circumstances that we may be unable to control, such as a general market disruption or an operational problem that affects our clients, third parties or us. Further, our ability to sell assets to generate liquidity may be impaired if other market participants are seeking to sell similar assets at the same time.
Our ability to raise capital in the long-term or short-term debt capital markets or the equity capital markets has been and could continue to be adversely affected by conditions in the United States and international markets and economy. Global market and economic conditions have been, and continue to be, disrupted and volatile. In particular, our cost and availability of raising debt capital may be adversely affected by illiquid credit markets and wider credit spreads. As a result of concern about the stability of the markets, the strength of counterparties and other factors, including the impact of the Dodd-Frank Act and other pending legislation and regulatory proposals, many lenders and institutional investors have reduced and, in some cases, ceased to provide funding to borrowers in the financial industry. In addition, our credit rating may impact our ability to obtain to raise additional long or short term capital. See the Risk Factor captioned "Our business may be adversely affected by a reduction in our credit ratings" To the extent we need to raise additional capital, including for acquisitions or meeting increased capital requirements arising from growth in our brokerage business, we may not be able to obtain such additional financing on acceptable terms or on a timely basis, if at all. If we cannot raise additional capital on acceptable terms, we may not be able to develop or enhance our business, take advantage of future opportunities or acquisitions, respond to competitive pressure or meet contractual, regulatory or other unanticipated requirements and as a result, our ability to conduct our business may be adversely affected.
Our business may be adversely affected by a reduction in our credit ratings.
There are a number of factors that might contribute to the possibility of having our credit rating downgraded by one or more credit rating agencies, including our profitability and results of operations and the general conditions of the economy and the global markets in which we provide our services. In the event of a downgrade of our credit rating by one or more credit rating agencies, our business may be adversely affected.
A reduction in our credit ratings would increase our borrowing costs under the 8.375% Senior Notes we issued in July 2011, which will mature in July 2018 ("8.375% Senior Notes"). In addition, any announcement by a rating agency that our credit rating is being downgraded could have a serious adverse impact on our business and, ultimately, on our operating results and financial condition. Moreover, concerns about our credit ratings may limit our ability to pursue acquisitions and, to the extent we pursue acquisitions that affect our credit ratings, our business may suffer. To avoid placing our credit rating at risk, we may need to limit the growth of our business, or we may even need to reduce our operations or other expenses to improve profitability. A credit-rating downgrade could also compel us to raise additional capital on unfavorable terms, which could result in substantial additional
interest or other expenses and lower earnings. If we were forced to raise equity capital, that action could result in substantial dilution to our existing shareholders.
The financial maintenance covenants in our Credit Agreement could limit the manner in which we conduct our business, and we may be unable to engage in favorable business activities or finance future operations or capital needs as a result.
We are party to a credit agreement with Bank of America N.A. and certain other lenders that provides for maximum borrowings of approximately $129 million (the "Credit Agreement"). The Credit Agreement matures in December 2013. Under our Credit Agreement we are required to satisfy and maintain specified financial ratios. Our ability to meet those financial ratios can be affected by events beyond our control, and there can be no assurance that we will meet those ratios. An adverse development affecting our business could require us to seek waivers or amendments of covenants, alternative or additional sources of financing or reductions in expenditures. We cannot assure you that such waivers, amendments or alternative or additional financings could be obtained or, if obtained, would be on terms acceptable to us. A failure to comply with the covenants contained in our Credit Agreement could result in an event of default thereunder or under other agreements, which, if not cured or waived could have a material adverse effect on our business, financial condition and results of operations. In the event of any default under our Credit Agreement, the lenders may not be required to lend any additional amounts to us, or could elect to declare all indebtedness outstanding, together with any accrued and unpaid interest and fees, to be due and payable and terminate all commitments to extend further credit. Such actions by the lenders could cause cross defaults under our other indebtedness, including the indenture governing our 8.375% Senior Notes.
Risks Related to Owning Our Stock
Jersey Partners has significant voting power and may take actions that may not be in the best interest of our other stockholders.
Jersey Partners Inc. ("JPI"), in which our chief executive officer and founder, Michael Gooch, is the controlling shareholder, owns approximately 41% of our outstanding common stock. Our president, Colin Heffron, is also a minority shareholder of JPI. As a result, through JPI, Michael Gooch has the ability to exert substantial influence over all matters requiring approval by our stockholders, including the election and removal of directors and any proposed merger, consolidation or sale of all or substantially all of our assets and other corporate transactions. This concentration of control could be disadvantageous to other stockholders with interests different from those of Michael Gooch. This concentration of voting power may have the effect of delaying or impeding actions that could be beneficial to our other stockholders, including actions that may be supported by our Board of Directors. The trading price for our common stock could be adversely affected if investors perceive disadvantages to owning our stock as a result of this significant concentration of share ownership.
Provisions of our certificate of incorporation and bylaws, agreements to which we are a party, regulations to which we are subject and provisions of our equity incentive plans could delay or prevent a change in control of our company and entrench current management.
Our second amended and restated certificate of incorporation and bylaws may be deemed to have an anti-takeover effect and may delay, deter or prevent a change of control of us, such as a tender offer or takeover proposal that might result in a premium over the market price for our common stock. In addition, certain of these provisions make it more difficult to bring about a change in the composition of our board of directors, which could result in entrenchment of current management. For example, our second amended and restated certificate of incorporation and bylaws:
Under our Credit Agreement and our 8.375% Senior Notes, a change in control may lead the lenders to exercise remedies such as acceleration of the loan and, in the case of the Credit Agreement, termination of their obligations to fund additional advances.
Our brokerage businesses are heavily regulated and some of our regulators require that they approve transactions which could result in a change of control, as defined by the then-applicable rules of our regulators. The requirement that this approval be obtained may prevent or delay transactions that would result in a change of control.
In addition, our equity incentive plans contain provisions pursuant to which our Board may, in its discretion, determine to accelerate the vesting of outstanding options or restricted stock units in the event of a change of control. If the Board determines to accelerate the vesting of these unvested grants, it could have the effect of dissuading potential acquirers from pursuing merger discussions with us.
If we fail to maintain effective internal control over financial reporting as required by Section 404 of the Sarbanes-Oxley Act, it may have an adverse effect on our business.
We are subject to the requirements of Section 404 of the Sarbanes-Oxley Act of 2002 ("SOX") and the applicable SEC rules and regulations that require our management to conduct an annual assessment and to report on the effectiveness of our internal controls over financial reporting. In addition, our independent registered public accounting firm must issue an attestation report addressing the operating effectiveness of the Company's internal controls over financial reporting.
While our internal controls over financial reporting currently meet all of the standards required by SOX, failure to maintain an effective internal control environment could have a material adverse effect on our business, financial condition and results of operations. We cannot be certain as to our ability to continue to comply with the requirements of SOX. If we are not able to continue to comply with the requirements of SOX in a timely manner or with adequate compliance, we may be subject to sanctions or investigation by regulatory authorities, including the SEC, PCAOB or FINRA. In addition, should we identify a material weakness, there can be no assurance that we would be able to remediate such material weakness in a timely manner in future periods. Moreover, if we are unable to assert that our internal control over financial reporting is effective in any future period (or if our auditors are unable to express an opinion on the effectiveness of our internal controls), we could lose investor confidence in the accuracy and completeness of our financial reports, and incur significant expenses to restructure our internal controls over financial reporting, which may have a material adverse effect on our Company.
We cannot provide assurance that we will continue to declare and pay dividends at all or in any particular amounts and we may elect not to pay dividends in the future.
Our Board of Directors has approved a policy of paying quarterly dividends, subject to available cash flow from operations, other considerations and the determination by our Board of Directors of the amount. However, there is no assurance that we will continue to declare and pay dividends at all or in any particular amounts and we may elect not to pay dividends in the future. Our dividend policy may be affected by, among other things, our earnings, financial condition, future capital requirements, level of indebtedness, contractual restrictions with respect to the payment of dividends, the issuance of special dividends from time to time, changes in tax rates and our determination to make certain investments or acquisitions. Our ability to declare a dividend is also subject to the limits imposed by Delaware corporate law and our Credit Agreement.
The market price of our common stock may fluctuate in the future, and future sales of our shares could adversely affect the market price of our common stock.
The market price of our common stock has fluctuated in the past and may fluctuate in the future depending upon many factors, including our actual results of operations and perceived prospects and the prospects of the financial marketplaces in general, differences between our actual financial and operating results and those expected by investors and analysts, changes in analysts' recommendations or projections, seasonality, changes in general valuations for companies in our business segment, changes in general economic or market conditions and broad market fluctuations.
Future sales of our common stock also could adversely affect the market price of our common stock. If our existing stockholders sell a large number of shares, or if we issue a large number of shares of our common stock in connection with future acquisitions, strategic alliances, new or amended equity incentive plans or otherwise, the market price of our common stock could decline significantly. Moreover, the perception in the public market that our stockholders, including JPI, might sell shares of common stock could depress the market price of our common stock.
As of December 31, 2011, we had registered under the Securities Act of 1933, as amended (the "Securities Act"), an aggregate of 602,592 shares of our common stock which are reserved for issuance upon the exercise of outstanding options under our 2000 and 2002 Stock Option Plans. In addition, as of December 31, 2011, we had registered under the Securities Act an aggregate of 30,400,000 shares of our common stock available for issuance under our 2008 Equity Incentive Plan in connection with existing and new grants of restricted stock units, stock options or similar types of equity compensation awards to our employees. Based on outstanding grants at December 31, 2011, there are 9,539,374 shares of our common stock available for future grants of awards under the 2008 Equity Incentive Plan. These shares can be sold in the public market upon issuance, subject to any vesting requirements and restrictions under the securities laws applicable to resale by affiliates. These sales might impact the liquidity of our common stock and might have a dilutive effect on existing stockholders making it more difficult for us to sell equity or equity-related securities in the future at a time and price that we deem appropriate.
We may be required to recognize impairments of our goodwill or other intangible assets, which could adversely affect our results of operations or financial condition.
Accounting standards require periodic testing for the impairment of goodwill and intangible assets. While we have not recognized any impairment of goodwill and intangible assets to date, any such non-cash charges in the future could have a material impact on our stockholders equity and our results of operations.
The determination of the value of goodwill and intangible assets requires management to make estimates and assumptions that affect our consolidated financial statements. We are required to test
goodwill for impairment annually, or in interim periods if certain events occur indicating that the carrying value may be impaired. We assess potential impairments to intangible assets when there is evidence that events or changes in circumstances indicate that the carrying amount of an asset may not be recovered. Our judgments regarding the existence of impairment indicators and future cash flows related to goodwill and intangible assets are based on several factors which include: the operational performance of any acquired businesses, management's current business plans which factor in current market conditions, market capitalization, the trading price of our common stock and trading volumes, as well as other factors. Management uses discounted cash flow analysis in their impairment assessments, which involves the subjective selection and interpretation of data inputs, and given market conditions at the testing date, can include a very limited amount of observable market inputs available in determining the model.
Changes to our business plan, increased macroeconomic weakness, declines in operating results and decreased market capitalization may result in our having to perform an interim goodwill impairment test or an intangible asset impairment test. These types of events and the resulting analysis could result in goodwill or intangible asset impairment charges in future periods.
We have offices in the United States, Europe, Latin America, Asia, the Middle East and South Africa. Our executive headquarters are located at 55 Water Street, New York, New York 10041, where we occupy approximately 89,000 square feet of leased space, pursuant to a lease that expires in December 2027. Our largest office outside of the New York metropolitan area is our U.K. headquarters, which is located in London at 1 Snowden Street, EC2 2DQ, where we occupy approximately 44,000 square feet pursuant to a lease that expires in March 2025.
Our U.S. operations also lease office space in Sugarland (TX), Los Angeles (CA), and Stamford (CT). Our foreign operations lease office space in London, Dublin, Paris, Nyon, Hong Kong, Seoul, Tokyo, Singapore, Sydney, Cape Town, Santiago, Bogota, Dubai and Tel Aviv. We believe our facilities will be adequate for our operations for the next twelve months.
In the normal course of business, we are and have been party to, or otherwise involved in, litigations, claims and arbitrations that involve claims for substantial amounts. These proceedings have generally involved either proceedings against our competitors in connection with employee hires, or claims from former employees in connection with the termination of their employment from us. There is also potential for client claims alleging the occurrence of errors in the execution of brokerage transactions. We are also currently and will, in the future, be involved, in examinations, investigations or proceedings by government agencies and self-regulatory organizations. These examinations or investigations could result in substantial fines or administrative proceedings that could result in censure, the issuance of cease and desist orders, the suspension or expulsion of a broker dealer and its affiliated persons, officers or employees or other similar consequences.
In October 2010, the staff of the Market Regulation Department of FINRA (the "Staff") commenced a disciplinary proceeding by filing a complaint against GFI Securities LLC and four of its former employees in connection with allegedly improper communications in 2005 and 2006 between certain of these former employees and those at other interdealer brokerage firms. All of the former employees of GFI Securities LLC who were named in the complaint resigned in April 2008 to become employed by affiliates of Compagnie Financiere Tradition. None of our current employees were named in the complaint. In February 2012, GFI Securities LLC reached an agreement with FINRA to settle this matter pursuant to which GFI Securities LLC will be censured and will pay a fine for violations of FINRA rule 2110, interpretive material 2110-5 and FINRA rule 3010. The amount of the fine will not have a material adverse impact on our financial position or results of operations.
Based on currently available information, the outcome of the Company's outstanding matters are not expected to have a material adverse impact on the Company's financial position. However, the outcome of any such matters may be material to the Company's results of operations or cash flows in a given period. It is not presently possible to determine the Company's ultimate exposure to these matters and there is no assurance that the resolution of the Company's outstanding matters will not significantly exceed any reserves accrued by the Company.
On October 5, 2010 we transferred the listing of our common stock from the Nasdaq Global Select Market ("Nasdaq") to the New York Stock Exchange Euronext ("NYSE Euronext"). Our common stock is traded under the symbol "GFIG," the same symbol that was used on the Nasdaq since our initial public offering on January 26, 2005. The closing share price for our common stock on February 29, 2012, as reported by NYSE Euronext, was $3.84.
As of February 29, 2012, we had approximately 46 holders of record of our common stock.
Set forth below, for each of the last eight fiscal quarters, is the low and high sales prices per share of our common stock as reported on Nasdaq through the third quarter of 2010 and NYSE Euronext in the fourth quarter of 2010 through the fourth quarter of 2011.
Prior to 2008, we retained all earnings for investment in our business. In February 2008, our Board of Directors approved a policy of paying quarterly dividends, subject to available cash flow from operations, other considerations and the determination by our Board of Directors of the amount.
Any declaration and payment of dividends will be at the discretion of our Board of Directors and will depend upon, among other things, our earnings, financial condition, capital requirements, level of indebtedness, contractual restrictions with respect to the payment of dividends, and other considerations that our Board of Directors deems relevant. The Board's ability to declare a dividend is also subject to limits imposed by Delaware corporate law. In addition, our subsidiaries are permitted to pay dividends to us subject to (i) certain regulatory restrictions related to the maintenance of minimum net capital in those of our subsidiaries that are subject to net capital requirements imposed by applicable law or regulation, and (ii) general restrictions imposed on dividend payments under the jurisdiction of incorporation or organization of each subsidiary. Finally, our Credit Agreement limits our ability to pay dividends in certain circumstances without the approval of our lenders and any instruments governing our future indebtedness may also contain various covenants that limit our ability to pay dividends.
The following performance graph shows a comparison, from December 31, 2006 through December 31, 2011, of the cumulative total return for our common stock, the NYSE Composite Index, Nasdaq Composite Stock Index, the Nasdaq Other Financial Index and our peer group. The peer group is comprised of ICAP plc, Tullet Prebon plc, Compagnie Financiere Tradition, MarketAxess Holdings Inc., BGC Partners Inc., Deutsche Boerse Group, IntercontinentalExchange Inc. and the CME Group Inc.
The performance graph assumes that the value of the initial investment in the Company's common stock, each index and the peer group was $100 on December 31, 2006 and that all dividends have been reinvested. Such returns are based on historical results and are not intended to suggest future performance. The returns of each company within the peer group have been weighted according to their respective stock market capitalization for purposes of arriving at a peer group average.
Recent Sales of Unregistered Securities
For the year ended December 31, 2011, we granted a total of 9,250,544 restricted stock units ("RSUs") to officers, directors and employees pursuant to our 2008 Equity Incentive Plan. The grant prices of these RSUs ranged from $4.02 to $5.12. These RSUs will be converted into common stock to be issued to the recipients of the RSUs as they vest, which is generally on an annual basis over three years. These RSUs were granted pursuant to exemptions from registration provided by Rule 701 and/or Section 4(2) under the Securities Act.
Purchase of Equity Securities
The table below sets forth the information with respect to purchases made by the Company of its common stock during the quarterly period ended December 31, 2011.
The following table sets forth selected consolidated financial data for the five years ended December 31, 2011. This selected financial data as of December 31, 2010, December 31, 2009, December 31, 2008 and December 31, 2007 has been updated to reflect the immaterial restatement as discussed in Note 2 to the Consolidated Financial Statements in Item 8 herein. This selected consolidated financial data should be read in conjunction with "Item 7Management's Discussion and Analysis of Financial Condition and Results of Operations" and with our consolidated financial statements and the notes thereto contained in Part II-Item 8 in this Form 10-K.
The following discussion of our financial condition and results of operations should be read in conjunction with our consolidated financial statements and the notes thereof in Part II-Item 8 hereof. This discussion contains forward-looking statements. Actual results could differ materially from the results discussed in these forward-looking statements. Please see "Forward-Looking Statements" and "Risk Factors" for a discussion of some of the uncertainties, risks and assumptions associated with these statements.
As a leading provider of wholesale brokerage services, clearing services and electronic execution and trading support products for global financial markets, our results of operations are impacted by a number of external market factors, including market volatility and transactional volumes, the organic growth or contraction of the derivative and cash markets in which we provide our brokerage services, the particular mix of transactional activity in our various products, the competitive and regulatory environment in the various jurisdictions and markets in which we operate and the financial condition of the dealers, hedge funds, traders and other market participants to whom we provide our services. Outlined below are management's observations of these external market factors during the most recent fiscal period. The factors outlined below are not the only factors that impacted our results of operations for the most recent fiscal period, and additional or other factors may impact, or have different degrees of impact, on our results of operations in future periods.
As a general rule, our business typically benefits from volatility in the markets that we serve, as periods of increased volatility often coincide with more robust trading by our clients and a higher volume of transactions. However, periods of extreme volatility may result in significant market dislocations that can also lead clients to reduce their trading activity.
Market volatility is driven by a range of external factors, some of which are market specific and some of which are correlated to general macro-economic conditions. During 2011, several of the markets in which we operate generally experienced higher volatility compared to 2010 due, in large part, to the continuing sovereign debt crisis and geo-political and market uncertainties. The increased market volatility led to a more favorable trading environment across all our geographic regions, especially in emerging markets, during many of the first nine months of 2011. However, we believe the extreme market volatility during the third quarter contributed to slower trading conditions in the fourth quarter of 2011 as market participants reduced their risk appetite and closed their trading positions earlier than in prior years.
Recent Growth in Underlying Markets
Our business has historically benefited from growth in the over-the-counter ("OTC") derivatives markets due to either the expansion of existing markets, including increased notional amounts outstanding or increased transaction volumes, or the development of new products or classes of products. The level of growth in these markets is difficult to measure on a quarterly basis as there are only a few independent, objective measures of growth in outstanding notional amount of OTC derivatives, all of which are published retrospectively and do not measure transactional volumes. Therefore, to help gauge growth in any particular quarter, management also looks to the published results of large OTC derivatives dealers and certain futures exchanges as potential indicators of transactional activity in the related OTC derivative markets.
According to the Bank of International Settlements ("BIS"), the size of the global OTC derivative markets, as measured by notional amounts outstanding, rose by 17.7% sequentially to $707.6 trillion in
the first half of 2011 from $601.0 trillion in the second half of 2010, and 21.4% year-over-year from $582.7 trillion in the first half of 2010. This compares to growth rates of 9.6% and 21.6% sequentially and year-over-year, respectively, for notional amounts outstanding in the exchange traded derivative markets over the same periods. OTC Interest rate and foreign exchange notional amounts outstanding grew 22.6% and 21.7%, respectively, year-over-year while credit default swaps grew at a lower rate of 7.1%. The interest rate and foreign exchange growth comes largely from currency swaps and interest rate swaps, respectively, while the growth rate in the notional amount of credit default swaps outstanding was accelerated by growth in multi-name (index) products.
The 2011 BIS statistics indicate the first significant growth in the OTC derivative markets since the global financial crisis started in 2008. The compound annual growth rates in OTC and exchange-traded notional amounts outstanding over the two year period ended December 31, 2010 were 0.2% and 8.5%, respectively, compared to compound annual growth rates of 24.9% and 9.5%, respectively, over the five years ended December 31, 2008. Following the financial crisis in 2008, OTC derivative growth had lagged that of exchange-traded products due to (i) a shift in market preference towards standardized, cleared or shorter dated products that typically trade on an exchange, (ii) regulatory uncertainty and (iii) the OTC industry's effort to net derivative exposure. However, heightened volatility in the markets and significant growth in interest rate and foreign exchange notional amounts outstanding have contributed to recent growth in OTC derivative products.
Another major external market factor affecting our business and results of operations is competition, which may take the form of competitive pressure on the commissions we charge for our brokerage services or competition for brokerage and technology development personnel with extensive experience in the specialized markets we serve. Competition for the services of productive brokers remained strong throughout 2011, although somewhat lesser than in prior periods. The consolidation and personnel layoffs by dealers, hedge funds and other market participants over the last few years has increased competition to provide brokerage services to a smaller number of market participants in the near term.
In addition, we believe the continuing global regulatory overhaul of many of the markets in which we provide our services led to uncertainty throughout 2011. Regulators and legislators in the U.S. and abroad have proposed and, in some instances, adopted a slate of regulatory changes that call for, among other things, central clearing of certain derivatives, greater transparency and reporting of derivatives transactions, mandatory trading of certain derivatives transactions on regulated exchanges or SEF and the required or increased use of electronic trading system technologies. We believe that the new and proposed regulations have not eliminated the uncertainty that has persisted in many OTC derivatives markets since the start of the financial crisis.
We are optimistic that unfolding regulatory reform, including requirements for enhanced regulatory transparency, central clearing and efficient execution will benefit and eventually grow the global derivatives markets. We remain confident that our business will qualify in the U.S. as a SEF, and in Europe as an Organized Trading Facility. Over the past year, we believe that several of our hybrid electronic trading platforms built upon their past successes and became more engrained in customer work-flows, which will enable us to more readily adjust to the new financial regulations.
Our results for the last three years reflect the challenging economic conditions that have existed following the late-2000s financial crisis during which many market participants, including many of our key customers, experienced reduced liquidity with continued credit contraction, financial institution consolidation and market participant bankruptcies. Our geographic and product diversity enabled us to
take advantage of areas of market strength over this period, even as several OTC derivative markets in which we provide our services were impacted by economic, market and regulatory uncertainty. As more fully discussed below, our results of operations are significantly impacted by the amount of our revenues and the amount of compensation and benefits we provide to our employees. The following factors had a significant impact on our revenues and employee costs during the three year period ended December 31, 2011:
Our total revenues increased 17.7% to $1.02 billion for the year ended December 31, 2011 from $862.6 million for the year ended December 31, 2010. The main factors contributing to this increase in our revenues were:
Partially offsetting these factors were negative factors that affected our brokerage and other revenues, including:
The main factors contributing to our increase in revenues for the year ended December 31, 2010 from the year ended December 31, 2009 are set forth below under "Year Ended December 31, 2010 Compared to the Year Ended December 31, 2009."
The most significant component of our cost structure is employee compensation and employee benefits, which includes salaries, sign-on bonuses, incentive compensation and related employee benefits and taxes. Our compensation and employee benefits have increased from $558.2 million for the year ended December 31, 2010 to $627.4 million for the year ended December 31, 2011. The main factors contributing to the increase were (i) increased headcount in brokers, back office and Trayport
employees, (ii) higher compensation expense related to Kyte and (iii) a charge taken in the fourth quarter of 2011 related to severance and other restructuring expenses.
Our compensation and employee benefits for all employees have both a fixed and variable component. Base salaries and benefit costs are primarily fixed for all employees while bonuses constitute the variable portion of our compensation and employee benefits. Within overall compensation and employee benefits, the employment cost of our brokerage personnel is the key component. Bonuses for brokerage personnel are primarily based on individual performance and/or the operating results of their related brokerage desk. Additionally, a portion of our bonus expense is subject to contractual guarantees that may require us to make bonus payments to brokers regardless of their performance in any particular period. For many of our brokerage employees, their bonuses constitute a significant component of their overall compensation. Broker performance bonus expense increased to $244.0 million for the year ended December 31, 2011 from $229.1 million for the year ended December 31, 2010, primarily due to higher brokerage revenues.
We may pay sign-on bonuses to certain newly-hired brokers and retention bonuses to certain of our existing brokers who agree to long-term employment agreements. These bonuses may be paid in the form of cash or restricted stock units ("RSUs") and are typically expensed over the term of the related employment agreement for cash bonuses and the related service period for RSUs, which is generally two to four years. These employment agreements typically contain provisions requiring repayment of all or a portion of the cash payment and forfeiture provisions for unvested RSUs should the employee voluntarily terminate his or her employment or if the employee's employment is terminated for cause during the initial term of the agreement. Compensation expense resulting from the amortization of broker sign-on and retention bonus payments increased to $41.6 million for the year ended December 31, 2011 from $32.0 million for the year ended December 31, 2010, primarily due to increased broker headcount and expenses incurred in the fourth quarter of 2011 related to severance and the restructuring of certain broker employment arrangements.
Results of Consolidated Operations
The following table sets forth our consolidated results of operations for the periods indicated. Beginning in the second quarter ended June 30, 2011, we changed the name of the income statement line item "Equity in earnings of unconsolidated brokerage businesses" to "Equity in net earnings of unconsolidated businesses". Additionally, we have reclassified amounts previously presented in the "Other expenses" line item into "Equity in net earnings of unconsolidated businesses." These changes have been applied to all periods presented. See Note 2 to our Consolidated Financial Statements in Part II-Item 8 for further discussion.
The following table sets forth our consolidated results of operations as a percentage of our revenues, net of interest and transaction-based expenses for the periods indicated:
Year Ended December 31, 2011 Compared to the Year Ended December 31, 2010
Net (Loss) Income
GFI's net loss for the year ended December 31, 2011 was $3.2 million as compared to net income of $25.6 million for the year ended December 31, 2010, a decrease of $28.8 million, or 112.5%. Total revenues increased by $152.9 million, or 17.7%, to $1.02 billion for the year ended December 31, 2011 from $862.6 million for the same period in the prior year. The increase in total revenues for the year ended December 31, 2011 was due, in large part, to the inclusion of a full year's revenue for our Kyte subsidiary, which we acquired on July 1, 2010. For the year ended December 31, 2011, as compared to the year ended December 31, 2010, Kyte's operations contributed an increase of $70.8 million to our
clearing services revenue, as well as increases to our brokerage revenues and to our equity in net earnings of unconsolidated businesses. The increase in total revenues was also due to (i) a $46.8 million increase in our brokerage revenues, as described below and (ii) an increase of $35.2 million in Other revenues, which is discussed in more detail below under the section "Other Revenues."
Total interest and transaction-based expenses increased by $67.1 million, to $134.7 million for the year ended December 31, 2011 from $67.6 million for the year ended December 31, 2010. The increase was primarily due to the inclusion of a full year of revenue for our Kyte subsidiary. Kyte incurs exchange, clearing and execution costs in order to provide clearing services to its customers.
Total expenses other than interest and transaction-based expenses increased by $117.5 million, or 15.4% to $880.7 million for the year ended December 31, 2011 from $763.2 million for the year ended December 31, 2010. The increase in total other expenses was largely attributable to (i) increased compensation and benefits expense, which resulted from a $19.4 million charge taken in 2011 related to severance and other restructuring expenses, (ii) increased salary expense related to an increased headcount in brokers, back office and Trayport employees, (iii) increased interest on borrowings due to the July 2011 issuance of $250.0 million of 8.375% Senior Notes and bond redemption costs associated with the July 2011 redemption of the entire $60.0 million principal amount of our senior secured notes which were due in January 2013 ("7.17% Senior Notes"), (iv) $8.8 million of impairment charges taken related to certain equity method investments and (v) an increase in expenses related to the inclusion of a full year of operations for our Kyte subsidiary, including increased expenses relating to compensation and employee benefits, communications and market data, and depreciation and amortization.
The following table sets forth the changes in revenues for the year ended December 31, 2011, as compared to the same period in 2010 (dollars in thousands, except percentage data):
Brokerage RevenuesWe offer our brokerage services in four broad product categories: fixed income, equity, financial, and commodity. Below is a discussion of our brokerage revenues by product category for the year ended December 31, 2011.
Clearing Services Revenue
Other revenues increased by $35.2 million for the year ended December 31, 2011 to $106.1 million from $70.9 million for the year ended December 31, 2010. This increase was largely related to (i) an increase in our software, analytics and market data revenue of $13.0 million, which was largely attributable to an increase in software revenues at our Trayport subsidiary, (ii) a net increase of $11.5 million in Other, which was due, in part, to a $6.9 million gain related to the fair value mark-to-market on the future purchase commitment to acquire the residual 30% equity interest in Kyte compared to a gain of $0.2 million in 2010, (iii) an increase of $6.5 million in equity in net earnings of unconsolidated businesses, which was primarily related to equity method investments in certain Kyte backed traders and brokerage operations acquired on July 1, 2010 and (iv) a net increase of $6.6 million related to the remeasurement of foreign currency transactions and balances. Foreign currency remeasurement gains and losses result from the remeasurement of asset and liability balances that are denominated in currencies other than the functional currency of the business unit involved in such transactions. These increases in Other were slightly offset by a net decrease of $3.9 million in net realized and unrealized losses related to hedges of certain non-U.S. dollar assets, as well as hedges of current and anticipated revenues denominated in foreign currencies.
Interest and Transaction-Based Expenses
The following table sets forth the changes in expenses for the year ended December 31, 2011 as compared to the same period in 2010 (dollars in thousands, except percentage data):
Compensation and Employee Benefits
All Other Expenses
Year Ended December 31, 2010 Compared to the Year Ended December 31, 2009
GFI's net income for the year ended December 31, 2010 was $25.6 million as compared to $16.3 million for the year ended December 31, 2009, an increase of $9.3 million or 57.1%. Total revenues increased by $42.3 million, or 5.2%, to $862.6 million for the year ended December 31, 2010 from $820.3 million for 2009. Our increased revenues were primarily due to our Kyte acquisition, investments in technology and brokerage staff, and growth in our commodity, financial and fixed income derivative product businesses. However, we were adversely affected by foreign exchange rates in 2010 to the extent we earned revenues denominated in Euros and the British Pound as these currencies were weaker, on average, relative to the U.S. Dollar than in 2009. We employed a total of 1,161 brokerage personnel at December 31, 2010 compared to 1,082 at December 31, 2009.
Total interest and transaction-based expenses increased by $37.2 million, or 122.4% to $67.6 million for 2010 from $30.4 million for 2009. The increase is primarily related to our clearing services business obtained in the acquisition of Kyte. Kyte incurs exchange, clearing and execution costs in order to provide clearing services to its customers. Total expenses other than interest and transaction-based expenses decreased by $3.5 million, or 0.5%, to $763.2 million for 2010 from $766.7 million in 2009. The decrease in expenses is primarily attributable to decreased compensation expense, which resulted from lower broker performance bonuses and the charge of $34.4 million taken in 2009 related to the renegotiation of certain employment agreements and severance. The decrease in these compensation expenses were partially offset by an increase in expenses related to communications and market data, travel and promotion, rent and occupancy, depreciation and amortization, professional fees related to acquisitions, investments in technology and brokerage staff, and investing resources in preparation for the new regulatory framework being developed in the U.S. and Europe.
The following table sets forth the changes in revenues for the year ended December 31, 2010, as compared to the same period in 2009 (dollars in thousands, except percentage data):
Brokerage RevenuesWe offer our brokerage services in four broad product categories: fixed income, equity, financial, and commodity. Below is a discussion of our brokerage revenues by product category for the year ended December 31, 2010.
Clearing Services Revenue
Other revenues increased by $2.3 million for the year ended December 31, 2010 to $70.9 million from $68.6 million in the same period in 2009. This increase was largely related to (i) an increase in our software, analytics and market data revenue of $6.3 million, which was attributable to an increase in software revenues at our Trayport subsidiary, (ii) $3.5 million equity in net earnings of unconsolidated businesses related to investments in certain Kyte operations acquired on July 1, 2010, for which there is no comparable amount in the prior period, (iii) a net increase of $3.2 million in Other, which was primarily related to certain other Kyte operations for which there is no comparable amount in the prior period, and (iv) a gain of $3.7 million as a result of remeasuring our existing equity
interest in an OTC brokerage business in the U.K. upon the purchase of the remaining 67% of the business on November 1, 2010 in an acquisition accounted for as a business combination achieved in stages. Offsetting this increase is a net decrease of $10.5 million related to the remeasurement of foreign currency transactions and balances. Foreign currency remeasurement gains and losses result from the remeasurement of asset and liability balances that are denominated in currencies other than the functional currency of the business unit undertaking such transactions.
Interest and Transaction-Based Expenses
The following table sets forth the changes in expenses for the year ended December 31, 2010 as compared to the same period in 2009 (dollars in thousands, except percentage data):
Compensation and Employee Benefits
All Other Expenses
Results of Segment Operations
Based on the nature of our operations, products and services in each geographic region, we determined that we have four operating segments:(i) Americas Brokerage, (ii) Europe, Middle East and Africa ("EMEA") Brokerage, (iii) Asia Brokerage, and (iv) Clearing and Backed Trading. Our brokerage operations provide brokerage services in four broad product categories: fixed income, financial, equity and commodity. Additionally, we present our operating segments as five reportable segments, which includes the four operating segments plus All Other. The All Other segment captures costs that are not directly assignable to one of the operating business segments, primarily consisting of our corporate business activities and operations from software, analytics and market data.
The following tables summarize our Total revenues, Revenues, net of interest and transaction-based expenses, Other expenses and Income (loss) before income taxes by segment:
Segment Results for the Year Ended December 31, 2011 Compared to the Year Ended December 31, 2010
revenues are entirely related to our Kyte operations, which we acquired on July 1, 2010. Accordingly the year ended December 31, 2011 is not directly comparable to the year ended December 31, 2010. Total revenues for Clearing and backed trading for the year ended December 31, 2011 consist primarily of clearing services revenues of $112.7 million, brokerage revenues from principal transactions of $16.2 million, equity in earnings of unconsolidated subsidiaries of $14.7 million and other income of $19.0 million.
Total interest and transaction-based expenses
expenses are entirely related to the operations of Kyte, which we acquired on July 1, 2010. Accordingly, the year ended December 31, 2011 is not directly comparable to the year ended December 31, 2010. Total expenses for Clearing and Backed trading for the year ended December 31, 2011 are comprised of, in large part, compensation and employee benefits expense of $18.4 million, communications and market data expense of $10.7 million and depreciation and amortization of $5.2 million.
Segment Results for the Year Ended December 31, 2010 Compared to the Year Ended December 31, 2009
Total interest and transaction-based expenses
and transaction-based fees for our Clearing and Backed Trading segment increased to $41.0 million for the year ended December 31, 2010 from zero the prior year. All of these expenses were incurred by Kyte following the acquisition on July 1, 2010 and are primarily due to transaction fees on clearing services of $39.9 million. Further discussion of the factors driving our interest and transaction-based fees are described above under "Year Ended December 31, 2010 Compared to the Year Ended December 31, 2009."
Quarterly Results of Operations
The following table sets forth, by quarter, our unaudited Statement of Operations data for the period from January 1, 2010 to December 31, 2011. Results of any period are not necessarily indicative of results for a full year and may, in certain periods, be affected by seasonal fluctuations in our business.
The following table sets forth our quarterly results of operations as a percentage of our Revenues, net of interest and transaction-based expenses, for the indicated periods: