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EX-32.2 - EXHIBIT 32.2 - Virtu KCG Holdings LLCkcgexhibit32210qq117.htm
EX-32.1 - EXHIBIT 32.1 - Virtu KCG Holdings LLCkcgexhibit32110qq117.htm
EX-31.2 - EXHIBIT 31.2 - Virtu KCG Holdings LLCkcgexhibit31210qq117.htm
EX-31.1 - EXHIBIT 31.1 - Virtu KCG Holdings LLCkcgexhibit31110qq117.htm
EX-10.2 - EXHIBIT 10.2 - Virtu KCG Holdings LLCkcgexhibit10210qq117.htm
EX-10.1 - EXHIBIT 10.1 - Virtu KCG Holdings LLCkcgexhibit10110qq117.htm


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
_______________________________________________  
FORM 10-Q
ý
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2017
OR
¨

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
000-54991
Commission File Number 
KCG HOLDINGS, INC.
(Exact name of registrant as specified in its charter)
DELAWARE
(State or other jurisdiction of incorporation or organization)
38-3898306
(I.R.S. Employer Identification Number)
300 Vesey Street, New York, NY 10282
(Address of principal executive offices and zip code)
Registrant’s telephone number, including area code: (646) 682-6000
_______________________________________________ 
Securities registered pursuant to Section 12(b) of the Act:
Title of each class
Name of each exchange on which registered
Class A Common Stock, $0.01 par value
New York Stock Exchange
Securities registered pursuant to Section 12(g) of the Act:
_______________________________________________ 
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  x    No ¨ 
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  x    No  ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer”, “smaller reporting company” and "emerging growth company" in Rule 12b-2 of the Exchange Act.
Large accelerated filer
 
ý
Accelerated filer
 
¨
 
 
 
 
 
 
Non-accelerated filer
 
¨
Smaller reporting company
 
¨

 
 
 
 
 
 
Emerging growth company
 
¨
 
 
 
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) 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  ¨    No  ý
Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest predictable date:
At May 4, 2017, the number of shares outstanding of the Registrant’s Class A Common Stock was 67,630,780 (including restricted stock units) and there were no shares outstanding of the Registrant’s Class B Common Stock or Preferred Stock.




KCG HOLDINGS, INC.
FORM 10-Q QUARTERLY REPORT
For the Quarter Ended March 31, 2017
TABLE OF CONTENTS
 
 
 
Page
 
 
 
PART I
FINANCIAL INFORMATION:
 
 
 
 
Item 1.
Financial Statements (Unaudited)
 
Consolidated Statements of Operations
 
Consolidated Statements of Comprehensive Income
 
Consolidated Statements of Financial Condition
 
Consolidated Statement of Changes in Equity
 
Consolidated Statements of Cash Flows
 
Notes to Consolidated Financial Statements
Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
Item 3.
Quantitative and Qualitative Disclosures About Market Risk
Item 4.
Controls and Procedures
 
 
 
PART II
OTHER INFORMATION:
 
 
 
 
Item 1.
Legal Proceedings
Item 1A.
Risk Factors
Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds
Item 3.
Defaults Upon Senior Securities
Item 4.
Mine Safety Disclosures
Item 5.
Other Information
Item 6.
Exhibits
Signatures
 





2



PART I
FINANCIAL INFORMATION
Item 1.
Financial Statements (Unaudited)

KCG HOLDINGS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)

 
For the three months ended March 31,
 
2017
 
2016
 
(In thousands, except per share amounts)
Revenues
 
 
 
Trading revenues, net
$
154,307

 
$
223,938

Commissions and fees
93,589

 
106,101

Interest, net
821

 
117

Investment income and other, net
6,656

 
15,268

Total revenues
255,373

 
345,424

Expenses
 
 
 
Employee compensation and benefits
66,003

 
97,586

Execution and clearance fees
72,795

 
73,634

Communications and data processing
39,020

 
35,657

Depreciation and amortization
19,038

 
21,905

Payments for order flow
17,121

 
12,655

Collateralized financing interest
11,761

 
9,163

Debt interest expense
9,330

 
9,492

Occupancy and equipment rentals
6,760

 
8,990

Professional fees
4,544

 
6,057

Business development
1,208

 
1,119

Other
8,197

 
9,201

Total expenses
255,777

 
285,459

(Loss) income before income taxes
(404
)
 
59,965

Income tax (benefit) expense
(3,616
)
 
22,800

Net income
$
3,212

 
$
37,165

Basic earnings per share
$
0.05

 
$
0.42

Diluted earnings per share
$
0.05

 
$
0.41

Shares used in computation of basic earnings per share
66,306

 
88,458

Shares used in computation of diluted earnings per share
67,642

 
89,605















The accompanying notes are an integral part of these consolidated financial statements.

3


KCG HOLDINGS, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Unaudited)


 
For the three months ended March 31,
 
2017
 
2016
 
(In thousands)
Net income
$
3,212

 
$
37,165

Other comprehensive income (loss):
 
 
 
Unrealized gain on available for sale securities, net of tax
170

 
68

Reclassification of realized gain from Other comprehensive income, net of tax
(2,956
)
 

Cumulative translation adjustment, net of tax
437

 
(133
)
Comprehensive income
$
863

 
$
37,100

 


























The accompanying notes are an integral part of these consolidated financial statements.

4


KCG HOLDINGS, INC.
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
(Unaudited)




 
March 31,
 
December 31,
 
2017
 
2016
Assets
(In thousands)
Cash and cash equivalents
$
669,869

 
$
632,234

Cash and cash equivalents segregated under federal and other regulations
3,600

 
3,000

Financial instruments owned, at fair value, including securities pledged to counterparties that had the right to deliver or repledge of $368,736 at March 31, 2017 and $314,720 at December 31, 2016:
 
 
 
Equities
2,179,211

 
2,343,033

Debt securities
128,932

 
177,698

Listed options
12,299

 
19,100

Other financial instruments

 
30

Total financial instruments owned, at fair value
2,320,442

 
2,539,861

Collateralized agreements:
 
 
 
Securities borrowed
1,594,442

 
1,688,222

Receivable from brokers, dealers and clearing organizations
801,678

 
832,785

Fixed assets and leasehold improvements, less accumulated depreciation and amortization
159,595

 
151,645

Investments
24,716

 
30,979

Goodwill and Intangible assets, less accumulated amortization
106,851

 
100,338

Deferred tax asset, net
109,877

 
109,861

Assets of business held for sale

 
8,194

Other assets
192,359

 
164,168

Total assets
$
5,983,429

 
$
6,261,287

Liabilities and equity
 
 
 
Liabilities
 
 
 
Financial instruments sold, not yet purchased, at fair value:
 
 
 
Equities
$
1,694,374

 
$
1,821,957

Debt securities
177,168

 
211,222

Listed options
35,835

 
12,961

Other financial instruments
598

 

Total financial instruments sold, not yet purchased, at fair value
1,907,975

 
2,046,140

Collateralized financings:
 
 
 
Securities loaned
459,533

 
372,631

Financial instruments sold under agreements to repurchase
952,584

 
1,027,775

Other collateralized financings
50,000

 
100,000

Total collateralized financings
1,462,117

 
1,500,406

Payable to brokers, dealers and clearing organizations
495,253

 
518,900

Payable to customers
52,315

 
23,580

Accrued compensation expense
36,695

 
132,406

Accrued expenses and other liabilities
163,343

 
156,828

Income taxes payable
63,236

 
71,391

Debt
455,183

 
454,353

Total liabilities
4,636,117

 
4,904,004

Equity
 
 
 
Class A Common Stock
 
 
 
Shares authorized: 1,000,000 at March 31, 2017 and December 31, 2016; Shares issued: 91,810 at March 31, 2017 and 90,309 at December 31, 2016; Shares outstanding: 66,665 at March 31, 2017 and 67,192 at December 31, 2016
918

 
903

Additional paid-in capital
1,457,412

 
1,439,412

Retained earnings
195,276

 
192,064

Treasury stock, at cost; 25,145 shares at March 31, 2017 and 23,116 shares at December 31, 2016
(306,192
)
 
(277,343
)
Accumulated other comprehensive (loss) income
(102
)
 
2,247

Total equity
1,347,312

 
1,357,283

Total liabilities and equity
$
5,983,429

 
$
6,261,287




The accompanying notes are an integral part of these consolidated financial statements.

5

KCG HOLDINGS, INC.
CONSOLIDATED STATEMENT OF CHANGES IN EQUITY
For the three months ended March 31, 2017
(Unaudited)




 
Class A Common
Stock
 
 
 
 
 
Treasury Stock
 
 
 
 
(in thousands)
Shares
 
Amount
 
Additional
Paid-In
Capital
 
Retained
Earnings
 
Shares
 
Amount
 
Accumulated
other
comprehensive
(loss) income
 
Total
Equity
Balance, December 31, 2016
90,309

 
$
903

 
$
1,439,412

 
$
192,064

 
(23,116
)
 
$
(277,343
)
 
$
2,247

 
$
1,357,283

KCG Class A Common Stock repurchased

 
$

 
$

 
$

 
(2,029
)
 
$
(28,849
)
 
$

 
$
(28,849
)
Stock-based compensation and Options & Warrants exercised
1,501

 
15

 
18,000

 

 

 

 

 
18,015

Unrealized gain on available for sale securities, net of tax

 

 

 

 

 

 
170

 
170

Reclassification of realized gain from Other comprehensive income, net of tax

 

 

 

 

 

 
(2,956
)
 
(2,956
)
Cumulative translation adjustment, net of tax

 

 

 

 

 

 
437

 
437

Net income

 

 

 
3,212

 

 

 

 
3,212

Balance, March 31, 2017
91,810

 
$
918

 
$
1,457,412

 
$
195,276

 
(25,145
)
 
$
(306,192
)
 
$
(102
)
 
$
1,347,312



























The accompanying notes are an integral part of these consolidated financial statements.

6


KCG HOLDINGS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)




 
For the three months ended March 31,
 
2017
 
2016
Cash flows from operating activities
(In thousands)
Net income
$
3,212

 
$
37,165

Adjustments to reconcile Net income to net cash provided by operating activities
 
 
 
Depreciation and amortization
19,038

 
21,905

Stock and unit-based compensation
2,997

 
17,110

Realized gain on sale of assets and investments
(4,834
)
 
(2,798
)
Realized gain on repurchase of debt

 
(3,676
)
Unrealized gain on investments
(117
)
 
(4,847
)
Other
618

 
2,750

(Increase) decrease in operating assets
 
 
 
Cash and cash equivalents segregated under federal and other regulations
(600
)
 

Financial instruments owned, at fair value
219,419

 
(92,151
)
Securities borrowed
93,780

 
(45,605
)
Receivable from brokers, dealers and clearing organizations
31,107

 
25,130

Other assets
(34,821
)
 
13,150

Increase (decrease) in operating liabilities
 
 
 
Financial instruments sold, not yet purchased, at fair value
(138,165
)
 
(57,943
)
Securities loaned
86,901

 
63,981

Financial instruments sold under agreements to repurchase
(75,191
)
 
(45,599
)
Other collateralized financing
(50,000
)
 

Payable to brokers, dealers and clearing organizations
(23,648
)
 
300,855

Payable to customers
28,735

 
(5,747
)
Accrued compensation expense
(77,207
)
 
(81,994
)
Accrued expenses and other liabilities
276

 
(9,357
)
Income taxes payable
(8,155
)
 

Net cash provided by operating activities
73,345


132,329

Cash flows from investing activities
 
 
 
Cash received from sale of KCG Hotspot
6,492

 
6,552

Cash received from sale of assets

 
4,970

Cash received from sale of investments and redemptions from investments
7,404

 
6,534

Purchases of fixed assets and leasehold improvements
(21,776
)
 
(12,677
)
Capitalization of software development costs
(17,725
)
 
(9,013
)
Purchases of investments
(869
)
 
(770
)
Net cash used in investing activities
(26,474
)

(4,404
)
Cash flows from financing activities
 
 
 
Repurchase of 6.875% Senior Secured Notes

 
(30,288
)
Borrowings under capital lease obligations
12,257

 

Principal payments on capital lease obligations
(568
)
 
(507
)
Cost of common stock repurchased
(28,849
)
 
(30,667
)
Stock options exercised
2,775

 

Warrants exercised
4,144

 

Cost of warrants repurchased

 
(967
)
Net cash used in financing activities
(10,241
)

(62,429
)
Effect of exchange rate changes on cash and cash equivalents
1,005

 
261

Increase in cash and cash equivalents
37,635


65,757

Cash and cash equivalents at beginning of period
632,234

 
581,313

Cash and cash equivalents at end of period
$
669,869


$
647,070

Supplemental disclosure of cash flow information:
 
 
 
Cash paid for interest
$
31,891

 
$
27,884

Cash paid for income taxes
$
1,535

 
$
9,955

Non-cash investing activities - Dividend received from joint venture
$
186

 
$

Non-cash investing activities - Compensation capitalized for internal use software that will be paid in a subsequent period
$
1,762

 
$

Non-cash financing activities - Warrants repurchased via GA Swap
$
2,929

 
$








The accompanying notes are an integral part of these consolidated financial statements.

7

KCG HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)



1. Organization and Description of the Business
KCG Holdings, Inc. (collectively with its subsidiaries, "KCG" or the "Company") is a leading independent securities firm offering clients a range of services designed to address trading needs across asset classes, product types and time zones. The Company combines advanced technology with specialized client service across market making, agency execution and trading venues and also engages in principal trading via exchange-based electronic market making. KCG has multiple access points to trade global equities, options, fixed income, currencies and commodities via voice or automated execution.
KCG was formed as a result of a strategic business combination (the “2013 Mergers”) of Knight Capital Group, Inc.(“Knight”) and GETCO Holding Company, LLC (“GETCO”) in July 2013.
Pending Merger with Virtu
On April 20, 2017, the Company entered into an Agreement and Plan of Merger (the “Merger Agreement”) with Virtu Financial, Inc., a Delaware corporation (“Virtu”) and Orchestra Merger Sub, Inc., a Delaware corporation and indirect wholly owned subsidiary of Virtu (“Merger Sub”). The Merger Agreement provides for the merger of Merger Sub with and into the Company (the “Merger”), with the Company surviving the Merger as a wholly owned subsidiary of Virtu.
Pursuant to the Merger Agreement, at the effective time of the Merger (the “Effective Time”), each share of Class A common stock of the Company, par value $0.01 per share ("KCG Class A Common Stock"), issued and outstanding immediately prior to the Effective Time (other than (i) Shares owned by Virtu, Merger Sub, any affiliate of Virtu or Merger Sub, or the Company, in each case immediately prior to the Effective Time, and (ii) Shares held by stockholders who have not voted in favor of the Merger and who have properly and validly perfected their statutory rights of appraisal in respect of such Shares in accordance with Section 262 of the Delaware General Corporation Law) will be canceled and converted into the right to receive $20.00 in cash without interest (the “Merger Consideration”), subject to applicable tax withholding. In accordance with the Merger Agreement, all unvested stock-based compensation awards that are outstanding as of immediately prior to the Effective Time shall accelerate and become fully vested and exercisable effective immediately prior to, and contingent upon, the Effective Time.
The respective obligations of the Company, Virtu and Merger Sub to consummate the Merger are subject to the satisfaction or waiver of certain customary conditions, including the adoption of the Merger Agreement by the Company’s stockholders, the receipt of certain required governmental approvals, the absence of any legal prohibitions, the accuracy of the representations and warranties (subject to customary materiality qualifiers) and compliance by the other party with its obligations under the Merger Agreement (subject to customary materiality qualifiers). The consummation of the Merger is not subject to a financing condition.
Concurrently with the execution of the Merger Agreement, Virtu entered into a voting agreement with Jefferies LLC (“Jefferies”), a stockholder of the Company, which requires Jefferies to, among other things, vote all of its shares of KCG Class A Common Stock in favor of adoption of the Merger Agreement.
The Company expects the Merger to close in the third quarter of 2017.
As of March 31, 2017, the Company's operating segments comprised the following: (i) Market Making; (ii) Global Execution Services; and (iii) Corporate and Other.
Market Making
The Market Making segment principally consists of market making in the cash, futures and options markets across global equities, options, fixed income, currencies and commodities. As a market maker, the Company commits capital on a principal basis by offering to buy securities from, or sell securities to, broker dealers, banks and institutions. The Company engages in principal trading in the Market Making segment direct to clients as well as in a supplemental capacity on exchanges, electronic communications networks (“ECNs”) and alternative trading systems (“ATSs”). The Company is an active participant on all major global equity and futures exchanges and also trades on substantially all domestic electronic options exchanges. As a complement to electronic market making, the cash trading business handles specialized orders and also transacts on the OTC Bulletin Board marketplaces operated by the OTC Markets Group Inc. and the Alternative Investment Market of the London Stock Exchange ("AIM").
Global Execution Services

8


KCG HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
(Unaudited)



The Global Execution Services segment comprises agency-based trading and trading venues, offering execution services in global equities, options, futures and fixed income on behalf of institutions, banks and broker dealers. The Company earns commissions as an agent on behalf of clients as well as between principals to transactions; in addition, the Company will commit capital on behalf of clients as needed. Agency-based, execution-only trading in the segment is done primarily through a variety of access points including: (i) algorithmic trading and order routing in global equities and options; (ii) institutional sales traders executing program, block and riskless principal trades in global equities and exchange traded funds ("ETFs"); (iii) a fixed income ECN that also offers trading applications; and (iv) an ATS for U.S. equities.
In September 2016, the Company completed the acquisition of Neonet Securities AB ("Neonet"). Neonet is an independent agency broker and execution specialist based in Stockholm, Sweden. The results of Neonet, beginning on the date of acquisition, are included in this segment. The Company does not consider this acquisition to be significant.
Corporate and Other
The Corporate and Other segment contains the Company's investments, principally in strategic trading-related opportunities; manages the deployment of capital across the organization; houses executive management functions; and maintains corporate overhead expenses and all other income and expenses that are not attributable to the Company's other segments. The Corporate and Other segment also contains functions that support the Company’s other segments such as self-clearing services, including stock lending activities.
Sales of Businesses
In March 2016, KCG completed the sale of assets related to its retail U.S. options market making business.
In May 2016, KCG completed the sale of its business as an equities designated market maker ("DMM") on the New York Stock Exchange ("NYSE") to Citadel Securities LLC (“Citadel”).
The results of both the retail U.S. options market making business and the DMM business are included in the Market Making segment, up through the date of the respective sales.
See Footnote 3 "Assets of Businesses Held for Sale & Sales of Businesses" for further information.
2. Significant Accounting Policies
Basis of consolidation and form of presentation
The accompanying unaudited Consolidated Financial Statements, prepared in conformity with accounting principles generally accepted in the United States of America (“GAAP”), should be read in conjunction with the audited Consolidated Financial Statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2016. These unaudited Consolidated Financial Statements include the accounts of the Company and its subsidiaries and reflect all normal and recurring adjustments that are, in the opinion of management, necessary for a fair statement of the results for the interim periods presented. Certain footnote disclosures normally included in financial statements prepared in accordance with GAAP have been condensed or omitted pursuant to U.S. Securities and Exchange Commission (“SEC”) rules and regulations, although the Company believes that the disclosures herein are adequate to make the information presented not misleading. All significant intercompany transactions and balances have been eliminated. Interim period operating results may not be indicative of the operating results for a full year.
Cash and cash equivalents
Cash and cash equivalents include money market accounts, which are payable on demand, and short-term investments with an original maturity of less than 90 days. The carrying amount of such cash equivalents approximates their fair value due to the short-term nature of these instruments. These assets would be categorized as Level 1 in the fair value hierarchy if they were required to be recorded at fair value.
Cash and cash equivalents segregated under federal and other regulations
The Company maintains custody of customer funds and is obligated by rules and regulations mandated by the SEC to segregate or set aside cash and/or qualified securities to satisfy these regulations, which have been promulgated to protect customer assets. The amounts recognized as Cash and cash equivalents segregated under federal and other regulations approximate fair value. These assets would be categorized as Level 1 in the fair value hierarchy if they were required to be recorded at fair value.

9


KCG HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
(Unaudited)



Market making, sales, trading and execution activities
Financial instruments owned and Financial instruments sold, not yet purchased relate to market making and trading activities, and include listed and other equity securities, listed equity options and fixed income securities that are recorded on a trade date basis and are reported at fair value. Such financial instruments are netted by their respective long and short positions by CUSIP/ISIN number. Trading revenues, net, which comprises trading gains, net of trading losses on such financial instruments, are also recorded on a trade date basis.
Commissions, which primarily comprise commission equivalents earned on institutional client orders and volume based fees earned from providing liquidity to other trading venues, as well as related expenses, are also recorded on a trade date basis.
The Company’s third party clearing agreements call for payment or receipt of interest income, net of transaction-related interest charged by such clearing brokers, for facilitating the settlement and financing of securities transactions. Interest income and interest expense which have been netted within Interest, net on the Consolidated Statements of Operations are as follows (in thousands):
 
For the three months ended March 31,
 
2017
 
2016
Interest Income
$
3,978

 
$
3,107

Interest Expense
(3,157
)
 
(2,990
)
Interest, net
$
821

 
$
117

Dividend income relating to financial instruments owned and dividend expense relating to financial instruments sold, not yet purchased, are derived primarily from the Company’s market making activities and are included as a component of Trading revenues, net on the Consolidated Statements of Operations. Trading revenues, net includes dividend income and expense as follows (in thousands):
 
For the three months ended March 31,
 
2017
 
2016
Dividend Income
$
10,360

 
$
11,921

Dividend Expense
$
(9,329
)
 
$
(9,148
)
Payments for order flow represent payments to broker dealer clients, in the normal course of business, for directing their order flow in U.S. equities and, prior to the sale of the retail U.S. options market making business, options to the Company.
 
Fair value of financial instruments
The Company values its financial instruments using a hierarchy of fair value that maximizes the use of observable inputs and minimizes the use of unobservable inputs when measuring fair value.
The fair value hierarchy can be summarized as follows:
Level 1—Valuations based on quoted prices in active markets for identical assets or liabilities that the Company has the ability to access. Since valuations are based on quoted prices that are readily and regularly available in an active market, valuation of these products does not entail a significant degree of judgment.
Level 2—Valuations based on quoted prices in markets that are not active or for which all significant inputs are observable, either directly or indirectly.
Level 3—Valuations based on inputs that are unobservable and significant to the overall fair value measurement.
Changes in fair value are recognized in earnings each period for financial instruments that are carried at fair value. See Footnote 4 “Fair Value” for a description of valuation methodologies applied to the classes of financial instruments at fair value.
Collateralized agreements and financings
Collateralized agreements consist of securities borrowed. Collateralized financings primarily comprise securities loaned and financial instruments sold under agreements to repurchase.

10


KCG HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
(Unaudited)



Securities borrowed and securities loaned transactions are recorded at the amount of cash collateral advanced or received. Securities borrowed transactions facilitate the securities settlement process and require the Company to deposit cash or other collateral with the lender. Securities loaned transactions help finance the Company’s securities inventory whereby the Company lends stock to counterparties in exchange for the receipt of cash or other collateral from the borrower. In these transactions, the Company receives or posts cash or other collateral in an amount generally in excess of the market value of the applicable securities borrowed or loaned. The Company monitors the market value of securities borrowed or loaned on a daily basis, and obtains additional collateral or refunds excess collateral as necessary.
Financial instruments sold under agreements to repurchase and other collateralized financings are used to finance inventories of securities and other financial instruments and are recorded at their contractual amount. The Company has entered into bilateral and tri-party term and overnight repurchase and other collateralized financing agreements which bear interest at negotiated rates. The Company receives cash and makes delivery of financial instruments to a custodian who monitors the market value of these instruments on a daily basis. The market value of the instruments delivered must be equal to or in excess of the principal amount loaned under the repurchase agreements plus the agreed upon margin requirement. The custodian may request additional collateral, if appropriate.
The Company’s securities borrowed, securities loaned, financial instruments sold under agreements to repurchase and other collateralized financings are recorded at amounts that approximate fair value. These items are recorded based upon their contractual terms and are not materially sensitive to shifts in interest rates because they are short-term in nature and are substantially collateralized pursuant to the terms of the underlying agreements. These items would be categorized as Level 2 in the fair value hierarchy if they were required to be recorded at fair value.
Investments
Investments primarily comprise noncontrolling equity ownership interests in trading-related businesses and are held by the Company's non-broker dealer subsidiaries. These investments are accounted for under the equity method, at cost, or at fair value. The equity method of accounting is used when the Company has significant influence over the operating and financial policies of the investee. Investments are held at cost, less impairment if any, when the investment does not have a readily determined fair value, and the Company is not considered to exert significant influence over operating and financial policies of the investee. Investments that are publicly traded and where the Company does not exert significant influence on operating and financial policies are held at fair value and accounted for as available for sale securities and any unrealized gains or losses are recorded net of tax in Other comprehensive income.
Investments accounted for under the equity method or held at cost are reviewed on an ongoing basis to determine whether the carrying values of the investments have been impaired. If the Company determines that an impairment loss on an investment has occurred due to a decline in fair value or other conditions, the investment is written down to its estimated fair value.
Included in the Company's investments are assets supporting a non-qualified deferred compensation plan for certain employees. This plan provides a return to the participants based upon the performance of various investments. In order to hedge its liability under this plan, the Company generally acquires the underlying investments and holds such investments until the deferred compensation liabilities are satisfied. Changes in value of such investments are recorded in Investment income and other, net, with a corresponding charge or credit to Employee compensation and benefits on the Consolidated Statements of Operations. Deferred compensation investments primarily consist of mutual funds, which are accounted for at fair value.
Goodwill and intangible assets
The Company tests goodwill and intangible assets with an indefinite useful life for impairment annually or when an event occurs or circumstances change that signifies that the carrying amounts may not be recoverable. Specific events and changes that could adversely affect the Company’s assessment of its Goodwill, which is all related to its Market Making reporting unit, include the following factors that are significant inputs into its fair value calculations of its reporting units and drive the Company's revenue and expense assumptions:
the inability to manage trading strategy performance and grow revenues and earnings;
changes in market structure, legislative, regulatory or financial reporting rules, including the increased focus by Congress, federal and state regulators, the self-regulatory organizations and the media on market structure issues, and in particular, the scrutiny of high frequency trading, alternative trading systems, market fragmentation,

11


KCG HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
(Unaudited)



colocation, access to market data feeds, and remuneration arrangements such as payment for order flow and exchange fee structures;
future changes to the Company’s organizational structure and management;
the Company’s ability to develop competitive new products and services in a timely manner and the acceptance of such products and services by the Company’s customers and potential customers;
the Company’s ability to keep up with technological changes;
the Company’s ability to effectively identify and manage market risk, operational and technology risk, cybersecurity risk, legal risk, liquidity risk, reputational risk, counterparty and credit risk, international risk, regulatory risk, and compliance risk;
the effects of increased competition and the Company’s ability to maintain and expand market share;
changes in discount and growth rates used by the Company in its fair value models; and
the Company's ability to manage its costs.
The Company amortizes intangible assets with finite lives on a straight line basis over their estimated useful lives and tests for recoverability whenever events indicate that the carrying amounts may not be recoverable. The Company capitalizes certain costs associated with the acquisition or development of internal-use software and amortizes the software over its estimated useful life of three years, commencing at the time the software is placed in service.
Payable to customers
Payable to customers primarily relate to amounts due on cash and margin transactions. Due to their short-term nature, such amounts approximate fair value.
Repurchases of common stock
The Company may repurchase shares of KCG Class A Common Stock in the open market or through privately negotiated transactions. The Company may structure such repurchases as either a purchase of treasury stock or a retirement of shares. The Company records its purchases of treasury stock, which include shares repurchased in satisfaction of tax withholding obligations upon vesting of restricted awards, at cost as a separate component of stockholders’ equity. The Company may re-issue treasury stock, at average cost, for the acquisition of new businesses and in certain other circumstances. For shares that are retired, the Company records its repurchases at cost, as a reduction in KCG Class A Common Stock for the par value of such retired shares and a reduction in Retained earnings for the balance.
Repurchases of warrants
As discussed in Footnote 15 "Warrants and Stock Repurchases", in connection with the 2013 Mergers, the Company issued Class A, Class B and Class C warrants to acquire shares of KCG Class A Common Stock ("Warrants"). The Company may repurchase Warrants through privately negotiated transactions. The Company records the total cost of its purchases of Warrants as a reduction in Additional paid-in capital.
Repurchases of debt
The Company may repurchase its 6.875% Senior Secured Notes in the open market or through privately negotiated transactions. The Company records its purchases of debt as a reduction in Debt for the par value repurchased as well as a prorated reduction of original issue discount and capitalized issuance costs. Total cost also includes accrued interest on the repurchased debt, which is included in Accrued expenses and other liabilities. The Company will record a gain to the extent that it repurchases debt at a price that is less than par value less the applicable original issue discount and capitalized issuance costs. Such gains are included within Investment income and other, net on the Consolidated Statements of Operations.
Foreign currency translation and foreign currency forward contracts
The Company's foreign subsidiaries generally use the U.S. dollar as their functional currency. The Company also has subsidiaries that utilize a functional currency other than the U.S. dollar, comprising its Indian subsidiary, which utilizes the Indian Rupee and, beginning in the third quarter of 2016, Neonet, which utilizes the Swedish Krona. None of these non-U.S. dollar functional currency subsidiaries are significant to the Company’s Consolidated Financial Statements.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
(Unaudited)



Assets and liabilities of these non-U.S. dollar functional currency subsidiaries are translated at exchange rates at the end of a period. Revenues and expenses are translated at average exchange rates during the period. Gains and losses resulting from translating foreign currency financial statements into U.S. dollars are included in Accumulated other comprehensive (loss) income on the Consolidated Statements of Financial Condition and Cumulative translation adjustment, net of tax on the Consolidated Statements of Comprehensive Income.
Gains or losses resulting from foreign currency transactions are included in Investment income and other, net on the Company’s Consolidated Statements of Operations. For the three months ended March 31, 2017 and 2016, the Company recorded gains of $0.2 million and $0.4 million, respectively, on foreign currency transactions.
The Company seeks to reduce the impact of fluctuations in foreign exchange rates on its net investment in certain non-U.S. operations through the use of foreign currency forward contracts. For foreign currency forward contracts designated as hedges, the Company assesses its risk management objectives and strategy, including identification of the hedging instrument, the hedged item and the risk exposure and how effectiveness is to be assessed prospectively and retrospectively. The effectiveness of the hedge is assessed based on the overall changes in the fair value of the forward contracts. For qualifying net investment hedges, any gains or losses, to the extent effective, are included in Accumulated other comprehensive (loss) income on the Consolidated Statements of Financial Condition and Cumulative translation adjustment, net of tax, on the Consolidated Statements of Comprehensive Income. The ineffective portion, if any, is recorded in Investment income and other, net on the Consolidated Statements of Operations.
Stock and unit based compensation
Stock and unit based compensation is primarily measured based on the grant date fair value of the awards. These costs are amortized over the requisite service period, if any. Expected forfeitures are considered in determining stock-based employee compensation expense. See Footnote 12 "Stock-Based Compensation" for further discussion.
Soft dollar expense
Under a commission management program, the Company allows institutional clients to allocate a portion of their gross commissions to pay for research and other services provided by third parties. As the Company acts as an agent in these transactions, it records such expenses on a net basis within Commissions and fees on the Consolidated Statements of Operations.
Depreciation, amortization and occupancy
Fixed assets are depreciated on a straight-line basis over their estimated useful lives of three to seven years. Leasehold improvements are being amortized on a straight-line basis, upon occupancy of the location, over the shorter of the term of the related office lease or the expected useful life of the assets. The Company reviews fixed assets and leasehold improvements for impairment, as well as their remaining useful lives whenever events or changes in circumstances indicate that the related carrying amounts may not be recoverable.
The Company recognizes rent expense under operating leases with fixed rent escalations, lease incentives and free rent periods on a straight-line basis over the lease term beginning on the date the Company takes possession of or controls the use of the space, including during free rent periods.
Lease loss accrual
The Company’s policy is to identify excess real estate capacity and where applicable, accrue for related future costs, net of projected sub-lease income upon the date the Company ceases to use the excess real estate. Such accrual is adjusted to the extent the actual terms of sub-leased property differ from the previous assumptions used in the calculation of the accrual.
Income taxes
The Company is a corporation subject to U.S. corporate income tax as well as non-U.S. income taxes in the jurisdictions in which it operates. The Company records deferred tax assets and liabilities for the expected future tax consequences of temporary differences between the financial reporting and tax bases of assets and liabilities and measures them using the enacted tax rates and laws that will be in effect when such differences are expected to reverse. The Company evaluates the recoverability of future tax deductions by assessing the adequacy of future expected taxable income from all sources, including reversal of temporary differences and forecasted operating earnings.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
(Unaudited)



Variable interest entities
A variable interest entity (“VIE”) is an entity that lacks one or more of the following characteristics (i) the total equity investment at risk is sufficient to enable the entity to finance its activities independently and (ii) the equity holders have the power to direct the activities of the entity that most significantly impact its economic performance, the obligation to absorb the losses of the entity and the right to receive the residual returns of the entity.
The Company will be considered to have a controlling financial interest and will consolidate a VIE if it has both (i) the power to direct the activities of the VIE that most significantly impact the VIE’s economic performance and (ii) the obligation to absorb losses of the VIE or the right to receive benefits from the VIE that could potentially be significant to the VIE.
Since January 2015, the Company has owned 50% of the voting shares and 50% of the equity of a joint venture (“JV”) which maintains microwave communication networks in the U.S. and Europe, and which is considered to be a VIE. The Company and its JV partner each pay monthly fees for the use of the microwave communication networks in connection with their respective trading activities, and the JV may sell excess bandwidth that is not utilized by the JV members to third parties.
In October 2016, the Company invested in another JV with nine other parties. Each party owns 10% of the voting shares and 10% of the equity of this JV, which is building microwave communication networks in the U.S. and Asia, and which is considered to be a VIE. The Company and all of its JV partners each pay monthly fees for the funding of the construction of the microwave communication networks. When completed, this JV may sell excess bandwidth that is not utilized by its joint venture members to third parties.
In each of the JVs, the Company does not have the power to direct the activities of the VIE that most significantly impact the VIE’s economic performance; therefore it does not have a controlling financial interest in the JVs and does not consolidate the JVs. The Company records its interest in the JVs under the equity method of accounting and records its investment in the JVs within Investments and its amounts payable for communication services provided by the JVs within Accrued expenses and other liabilities on the Consolidated Statements of Financial Condition. The Company records its pro-rata share of the JVs earnings or losses within Investment income and other, net and fees related to the use of communication services provided by the JVs within Communications and data processing on the Consolidated Statements of Operations.
The Company’s exposure to the obligations of these VIEs is generally limited to its interests in each respective JV, which is the carrying value of the equity investment in each JV.
The following table presents the Company’s nonconsolidated VIEs at March 31, 2017 (in thousands):
 
 
Carrying Amount
 
Maximum Exposure to loss
 
 
 
 
Asset
 
Liability
 
 
VIEs' assets
Equity investment
 
$
15,543

 
$
314

 
$
15,543

 
$
41,569

The following table presents the Company’s nonconsolidated VIE at December 31, 2016 (in thousands):
 
 
Carrying Amount
 
Maximum Exposure to loss
 
 
 
 
Asset
 
Liability
 
 
VIE's assets
Equity investment
 
$
14,822

 
$
500

 
$
14,822

 
$
36,715

Use of estimates
The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results may differ from those estimates.
Recently adopted accounting guidance
In March 2016, the FASB issued an ASU which simplifies several aspects of the accounting for employee share-based payment transactions including the accounting for income taxes, forfeitures and classification on the statement of cash flows. The Company adopted this ASU prospectively as of January 1, 2017. Following the adoption of this ASU:

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
(Unaudited)



the Company records all excess tax benefits and tax deficiencies as an income tax benefit or expense in the Consolidated Statements of Operations in the period in which they are realized. Previously such excess tax benefits and deficiencies were recorded within Additional paid-in capital on the Consolidated Statements of Financial Condition, although in certain circumstances tax deficiencies could have been recognized as income tax expense.
excess tax benefits and tax deficiencies are classified in operating activities, specifically within changes in Accrued expenses and other liabilities, in the Consolidated Statements of Cash Flows. Prior to the adoption of this ASU, the Company reported excess tax benefits and tax deficiencies as a financing activity on its Consolidated Statements of Cash Flows.
the Company no longer includes any assumed proceeds of any windfall tax benefits when applying the treasury stock method for computing diluted EPS. This may result in higher diluted shares outstanding for EPS calculations.
the Company elected to continue to estimate its forfeiture rate on grant date. Therefore, a cumulative effect adjustment was not necessary upon adoption of this ASU.
Recent accounting guidance to be adopted in future periods
In May 2014, the FASB issued an ASU that updates the principles for recognizing revenue. The core principle of the guidance is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. In March 2016, the FASB issued an ASU to clarify guidance on principal versus agent evaluation considerations and whether an entity reports revenue on a gross or net basis. These ASUs will be effective for interim and annual reporting periods beginning after December 15, 2017. Early adoption is permitted for reporting periods beginning after December 15, 2016. The Company has not yet determined its transition approach. Because the guidance does not apply to revenue associated with securities trading activities that are accounted for under other GAAP, the Company does not expect the guidance to have a material impact on its Consolidated Statements of Operations most closely associated with financial instruments, including Trading revenues, net, Commissions and fees, and Interest, net. The Company’s implementation efforts include the identification of revenue within the scope of the guidance and the evaluation of certain revenue contracts. The Company’s evaluation of the impact of the new guidance on its Consolidated Financial Statements is ongoing, and it continues to evaluate the timing of recognition for various revenues, including soft dollar related activity, which may be impacted depending on the features of the client arrangements and the presentation of certain contract costs (whether presented gross or offset against revenues).
In January 2016, the FASB issued an ASU that provides entities guidance for the accounting for equity investments, financial liabilities under the fair value option and the presentation and disclosure requirements of financial instruments. The guidance is effective for reporting periods beginning after December 15, 2018 and early adoption is permitted under a modified retrospective approach for certain financial liabilities as specified in this ASU. The Company does not expect the adoption of this ASU to have an impact on its Consolidated Financial Statements.
In February 2016, the FASB issued an ASU which requires lessees to recognize a right-to-use asset and a lease obligation for all leases. Lessees are permitted to make an accounting policy election to not recognize an asset and liability for leases with a term of twelve months or less. Additional qualitative and quantitative disclosures, including significant judgments made by management, will be required. The guidance is effective for reporting periods beginning after December 15, 2018 and early adoption is permitted under a modified retrospective approach. The Company is evaluating the impact of this ASU on its Consolidated Financial Statements.
In August 2016, the FASB issued an ASU which clarifies the presentation and classification of certain cash receipts and cash payments in the statement of cash flows. This ASU is effective for reporting periods beginning after December 15, 2017 and early adoption is permitted. The Company does not expect the adoption of this ASU to have a significant impact on its Consolidated Financial Statements.
In November 2016, the FASB issued an ASU which requires that cash segregated for regulatory and other purposes, generally described as restricted cash or restricted cash equivalents, be included in cash and cash equivalents disclosed in the statements of cash flows. The guidance is effective for all reporting periods beginning after December 15, 2017. Early adoption is permitted and must be applied retrospectively to all periods presented within the statement of cash flows. The Company does not expect the adoption of this ASU to have an impact on its Consolidated Financial Statements.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
(Unaudited)



In January 2017, the FASB issued an ASU which simplifies the accounting for goodwill impairments. This ASU eliminates the two-step process that required identification of potential impairment and a separate measure of the actual impairment. Goodwill impairment charges, if any, would be determined by reducing the goodwill balance by the difference between the carrying value and the reporting unit’s fair value. The impairment charge would be limited to the carrying value of goodwill. This ASU is effective for annual and interim impairment tests for periods beginning after December 15, 2021. Early adoption is allowed for annual and interim impairment tests occurring after January 1, 2017. The Company does not expect the adoption of this ASU to have a significant impact on its Consolidated Financial Statements.
In January 2017, the FASB issued an ASU to clarify the definition of a business with the objective of adding guidance to assist entities with evaluating whether transactions should be accounted for as acquisitions (or disposals) of assets or businesses. The ASU is effective for reporting periods beginning after December 15, 2017. The Company does not expect the adoption of this ASU to have a significant impact on its Consolidated Financial Statements.
3. Assets of Business Held for Sale & Sales of Businesses
In March 2015, the Company sold its spot institutional foreign exchange ECN, KCG Hotspot, to Bats Global Markets, Inc. ("Bats"). As part of the sale, the Company and Bats have agreed to share certain tax benefits, which could result in future payments to the Company of up to approximately $70.0 million in the three-year period following the close, consisting of a $50.0 million payment in 2018 and annual payments of up to $6.6 million per year (the "Annual Payments"), from 2016 up to and including 2018. On March 1, 2017, Bats merged with CBOE Holdings, Inc. (“CBOE”) (the “Bats Merger”). The remaining Annual Payments are contingent on CBOE generating sufficient taxable net income to receive the tax benefits.
The Company has elected the fair value option related to the receivable from Bats and considers the receivable to be a Level 2 asset in the fair value hierarchy as the fair value is derived from observable significant inputs such as contractual cash flows and market discount rates. KCG received the first and second Annual Payments of $6.6 million and $6.5 million in March 2016 and 2017, respectively. The remaining additional potential payments of $56.8 million are recorded at a fair value of $54.1 million in Other assets on the Consolidated Statement of Financial Condition as of March 31, 2017.
In accordance with the Company's strategic review of its businesses and evaluation of their potential value in the marketplace relative to their current and expected returns, KCG determined in 2015 that certain of its businesses including its DMM and retail options market making businesses, were no longer considered core to its strategy.
Assets of businesses held for sale are recorded at the lower of their book value or their estimated fair value and are reported as Assets of business held for sale on the Consolidated Statements of Financial Condition. Included in the $8.2 million of Assets of business held for sale at December 31, 2016 were assets related to a technology platform. At March 31, 2017, the Company determined that this business was no longer held for sale and as a result, reclassified the assets back to intangible assets on the Consolidated Statements of Financial Condition. The Company does not have any businesses that are considered to be held for sale at March 31, 2017. See Footnote 9 "Goodwill and Intangible Assets" for further details.
Assets related to the Company's retail options market making business, which were sold to a third party in March 2016 resulted in a gain of $2.9 million, which is included in Investment income and other, net on the Consolidated Statement of Operations for the three months ended March 31, 2016. The DMM business was sold to Citadel in May 2016. As charges were recorded in the fourth quarter of 2015 to reflect the estimated fair value of this held for sale business, no gain or loss on sale was recorded in 2016.
The assets of businesses held for sale as December 31, 2016 are summarized as follows (in thousands):
 
December 31,
2016
Assets:
 
Intangible assets, net of accumulated amortization
$
8,194

Total assets of businesses held for sale
$
8,194


16


KCG HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
(Unaudited)



4. Fair Value
The Company’s financial instruments recorded at fair value have been categorized based upon a fair value hierarchy in accordance with accounting guidance, as described in Footnote 2 “Significant Accounting Policies.” The following fair value hierarchy table presents information about the Company’s financial assets and liabilities measured at fair value (in thousands):
 
 
Assets and Liabilities Measured at
Fair Value on a Recurring Basis
March 31, 2017
 
Level 1
 
Level 2
 
Level 3
 
Total
Assets
 
 
 
 
 
 
 
 
Financial instruments owned, at fair value:
 
 
 
 
 
 
 
 
Equities
 
$
2,179,211

 
$

 
$

 
$
2,179,211

Corporate debt
 
91,314

 

 

 
91,314

U.S. government and Non-U.S. government obligations
 
37,618

 

 

 
37,618

Listed options
 
12,299

 

 

 
12,299

Total Financial instruments owned, at fair value
 
2,320,442

 

 

 
2,320,442

Investments(1)
 
2,379

 
2,234

 

 
4,613

Other (2)
 

 
54,142

 
2,838

 
56,980

Total assets held at fair value
 
$
2,322,821

 
$
56,376

 
$
2,838

 
$
2,382,035

Liabilities
 

 
 
 

 

Financial instruments sold, not yet purchased, at fair value:
 
 
 
 
 
 
 
 
Equities
 
$
1,694,374

 
$

 
$

 
$
1,694,374

Corporate debt
 
85,926

 

 

 
85,926

U.S. government and Non-U.S. government obligations
 
91,242

 

 

 
91,242

Listed options
 
35,835

 

 

 
35,835

Foreign currency forward contracts
 

 
598

 

 
598

Total liabilities held at fair value
 
$
1,907,377

 
$
598

 
$

 
$
1,907,975

(1) 
Investments comprise $2.4 million of Level 1 investments in CME Group and $2.2 million of Level 2 investments primarily related to deferred compensation investments, all of which are included within Investments on the Consolidated Statements of Financial Condition. See Footnote 8 "Investments" for additional information.
(2) 
Other primarily consists of a $54.1 million receivable from Bats related to the sale of KCG Hotspot and a $2.8 million receivable from the sale of an investment, both of which are included within Other Assets on the Consolidated Statements of Financial Condition.


17


KCG HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
(Unaudited)



 
 
Assets and Liabilities Measured at
Fair Value on a Recurring Basis
December 31, 2016
 
Level 1
 
Level 2
 
Level 3
 
Total
Assets
 
 
 
 
 
 
 
 
Financial instruments owned, at fair value:
 
 
 
 
 
 
 
 
Equities
 
$
2,343,033

 
$

 
$

 
$
2,343,033

Corporate debt
 
127,237

 

 

 
127,237

U.S. government and Non-U.S. government obligations
 
50,461

 

 

 
50,461

Listed options
 
19,100

 

 

 
19,100

Foreign currency forward contracts
 

 
30

 

 
30

Total Financial instruments owned, at fair value
 
2,539,831

 
30

 

 
2,539,861

Investments (1)
 
9,198

 
2,286

 

 
11,484

Other (2)
 

 
60,538

 
2,846

 
63,384

Total assets held at fair value
 
$
2,549,029

 
$
62,854

 
$
2,846

 
$
2,614,729

Liabilities
 
 
 
 
 
 
 
 
Financial instruments sold, not yet purchased, at fair value:
 
 
 
 
 
 
 
 
Equities
 
$
1,821,957

 
$

 
$

 
$
1,821,957

Listed options
 
12,961

 

 

 
12,961

U.S. government obligations
 
87,661

 

 

 
87,661

Corporate debt
 
123,561

 

 

 
123,561

Total liabilities held at fair value
 
$
2,046,140

 
$

 
$

 
$
2,046,140

(1) 
Investments comprise $9.2 million of Level 1 investments in CME Group and Bats and also includes $2.3 million of Level 2 investments primarily related to deferred compensation investments, all of which are included within Investments on the Consolidated Statements of Financial Condition. See Footnote 8 "Investments" for additional information.
(2) 
Other primarily consists of a $60.5 million receivable from Bats related to the sale of KCG Hotspot and a $2.8 million receivable from the sale of an investment, both of which are included in Other assets on the Consolidated Statements of Financial Condition.
The Company's derivative financial instruments are also held at fair value. See Footnote 5 "Derivative Financial Instruments" for further information.
The Company’s equities, listed options, U.S. government and non-U.S. government obligations, corporate debt and strategic investments that are publicly traded and for which the Company does not exert significant influence on operating and financial policies are generally classified within Level 1 of the fair value hierarchy because they are valued using quoted market prices or broker or dealer quotations with reasonable levels of price transparency.
The types of instruments that trade in markets that are not considered to be active, but are valued based on observable inputs such as quoted market prices or alternative pricing sources with reasonable levels of price transparency are generally classified within Level 2 of the fair value hierarchy.
As of March 31, 2017 and December 31, 2016, a receivable related to the sale of an investment was classified within Level 3 of the fair value hierarchy.
There were no transfers of assets or liabilities held at fair value between levels of the fair value hierarchy for any periods presented.
The following is a summary of changes in fair value of the Company's financial assets that have been categorized within Level 3 of the fair value hierarchy at March 31, 2017 and December 31, 2016 (in thousands):
 
Level 3 Financial Assets as of March 31, 2017
 
Balance at January
1, 2017
 
Realized gains(losses) during period
 
Unrealized gains (losses) during the period
 
Purchases
 
Sales
 
Settlements
 
Issuances
 
Transfers in or (out) of Level 3
 
Balance at March 31, 2017
Receivable from sold investment
$
2,846

 
$

 
$
(8
)
 
$

 
$

 
$

 
$

 
$

 
$
2,838


18


KCG HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
(Unaudited)



 
Level 3 Financial Assets as of December 31, 2016
 
Balance at January
1, 2016
 
Realized gains(losses) during period
 
Unrealized gains (losses) during the period
 
Purchases
 
Sales
 
Settlements
 
Issuances
 
Transfers in or (out) of Level 3
 
Balance at December 31, 2016
Receivable from sold investment
$
5,789

 
$

 
$
980

 
$

 
$

 
$
(3,923
)
 
$

 
$

 
$
2,846

Unrealized gains or losses are included within Investment income and other, net on the Consolidated Statements of Operations.
The following is a description of the valuation basis, techniques and significant inputs used by the Company in valuing its Level 2 and Level 3 assets and liabilities.
Foreign currency forward contracts
At March 31, 2017 and December 31, 2016, the Company had a foreign currency forward contract with a notional value of 735.0 million Indian Rupees ($11.3 million). This forward contract is used to hedge the Company’s investment in its Indian subsidiary.
The fair value of these forward contracts were determined based upon spot foreign exchange rates and dealer quotations.
Investments
Investments primarily include deferred compensation investments which comprise investments in liquid mutual funds that the Company acquires to hedge its obligations to employees under certain non-qualified deferred compensation arrangements. These mutual fund investments can generally be redeemed at any time and are valued based upon quoted market prices.
Other
Other primarily consists of the fair value of the Company's receivable from Bats/CBOE from the sale of KCG Hotspot as more fully described in Footnote 3 "Assets of Business Held for Sale & Sales of Businesses".
The Company has elected the fair value option related to its receivable from Bats/CBOE. It considers the receivable to be a Level 2 asset in the fair value hierarchy as the fair value is derived from observable significant inputs such as contractual cash flows and market discount rates.
The Company has elected the fair value option related to a receivable originating from the sale of an investment which is classified within Level 3 of the fair value hierarchy. As of March 31, 2017, the range of undiscounted amounts the Company may receive for this receivable is between $0 and $4.6 million. The valuation of this financial instrument was based upon the use of a model developed by Company management. Inputs into this model were based upon risk profiles of similar financial instruments in the market and reflects management’s judgment relating to the appropriate discount on the receivable as well as a financial assessment of the debtor. To the extent that valuations based on models or inputs that are less observable or unobservable in the market, the determination of fair value requires more judgment. Movements in these unobservable inputs would not materially impact the Company's results of operations.
5. Derivative Financial Instruments
The Company enters into derivative transactions as part of its trading activities and to manage foreign currency exposure. Cash flows associated with such derivative activities are included in cash flows from operating activities on the Consolidated Statements of Cash Flows.
During the normal course of business, the Company enters into futures contracts. These financial instruments are subject to varying degrees of risks whereby the fair value of the securities underlying the financial instruments may be in excess of, or less than, the contract amount. The Company is obligated to post collateral against certain futures contracts.
The Company has entered into and may continue to enter into International Swaps and Derivative Association, Inc. (“ISDA”) master netting agreements with counterparties. Master agreements provide protection in bankruptcy in certain circumstances and, where legally enforceable, enable receivables and payables with the same counterparty to be settled or otherwise eliminated by applying amounts due against all or a portion of an amount due from the

19


KCG HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
(Unaudited)



counterparty or a third party. The Company may also enter into bilateral trading agreements and other customer agreements that provide for the netting of receivables and payables with a given counterparty as a single net obligation.
Under the ISDA master netting agreements, the Company typically also executes credit support annexes, which provide for collateral, either in the form of cash or securities, to be posted or paid by a counterparty based on the fair value of the derivative receivable or payable based on the rates and parameters established in the credit support annex. In the event of counterparty’s default, provisions of the ISDA master agreement permit acceleration and termination of all outstanding transactions covered by the agreement such that a single amount is owed by, or to, the non-defaulting party. Any collateral posted can be applied to the net obligations, with any excess returned and the collateralized party has a right to liquidate the collateral. Any residual claim after netting is treated along with other unsecured claims in bankruptcy court.
The Company is also a party to clearing agreements with various central clearing parties. Under these arrangements, the central clearing counterparty facilitates settlement between counterparties based on the net payable owed or receivable due and, with respect to daily settlement, cash is generally only required to be deposited to the extent of the net amount. In the event of default, a net termination amount is determined based on the market values of all outstanding positions and the clearing organization or clearing member provides for the liquidation and settlement of the net termination amount among all counterparties to the open derivative contracts.
The following tables summarize the fair value and number of derivative instruments held at March 31, 2017 and December 31, 2016. These instruments include those classified as Financial instruments owned, at fair value, Financial instruments sold, not yet purchased, at fair value, as well as futures contracts and bi-lateral over the counter swaps which are reported within Receivable from brokers, dealers and clearing organizations on the Consolidated Statements of Financial Condition. The fair value of assets/liabilities are shown gross of counterparty netting and cash collateral received and pledged. The following tables also provide information regarding 1) the extent to which, under enforceable master netting agreements, such balances are presented net on the Consolidated Statements of Financial Condition as appropriate under GAAP, and 2) the extent to which other rights of setoff associated with these agreements exist and could have an effect on the Company's financial position (in thousands, except contract amounts):
 
 
 
March 31, 2017
 
Financial Statements
 
Assets
 
Liabilities
 
Location
 
Fair Value
 
Contracts
 
Fair Value
 
Contracts
Foreign currency
 
 
 
 
 
 
 
 
 
Futures contracts
Receivable from brokers, dealers and clearing organizations
 
$
163

 
364

 
$
240

 
438

Forward contracts (1)
Financial instruments owned, at fair value
 

 

 
598

 
1

Equity
 
 
 
 
 
 
 
 
 
Futures contracts
Receivable from brokers, dealers and clearing organizations
 
1,594

 
7,047

 
2,978

 
7,326

Swap contracts
Receivable from brokers, dealers and clearing organizations
 

 

 
195

 
2

Listed options
Financial instruments owned/sold, not yet purchased, at fair value
 
12,299

 
75,294

 
35,835

 
76,347

Fixed income
 
 
 
 
 
 
 
 
 
Futures contracts
Receivable from brokers, dealers and clearing organizations
 
2,545

 
4,234

 
5,678

 
4,038

Commodity
 
 
 
 
 
 
 
 
 
Futures contracts
Receivable from brokers, dealers and clearing organizations
 
45,889

 
23,531

 
45,697

 
25,762

Gross derivative assets/liabilities, before netting
 
$
62,490

 
 
 
$
91,221

 
 
Less: Legally enforceable master netting agreements
 
 
 
 
 
 
 
 
Exchange traded (3)
 
(49,841
)
 
 
 
(54,593
)
 
 
Bi-lateral over-the-counter (4)
 

 
 
 
(195
)
 
 
Net amounts per Consolidated Statement of Financial Condition (5)
 
$
12,649

 
 
 
$
36,433

 
 

20


KCG HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
(Unaudited)



 
 
 
December 31, 2016
 
Financial Statements
 
Assets
 
Liabilities
 
Location
 
Fair Value
 
Contracts
 
Fair Value
 
Contracts
Foreign currency
 
 
 
 
 
 
 
 
 
Futures contracts
Receivable from brokers, dealers and clearing organizations
 
$
360

 
1,285

 
$
1,663

 
6,495

Forward contracts (1)
Financial instruments owned, at fair value
 
30

 
1

 

 

Equity
 
 
 
 
 
 
 
 
 
Futures contracts
Receivable from brokers, dealers and clearing organizations
 
1,451

 
2,056

 
1,644

 
2,944

Swap contracts
Receivable from brokers, dealers and clearing organizations
 
16

 
1

 
154

 
1

Listed options
Financial instruments owned/sold, not yet purchased, at fair value
 
19,100

 
85,797

 
12,961

 
90,063

Forward contracts(2)
Accrued expenses and other liabilities
 

 

 
1,599

 
1

Fixed income
 
 
 
 
 
 
 
 
 
Futures contracts
Receivable from brokers, dealers and clearing organizations
 
4,627

 
8,590

 
5,541

 
5,165

Commodity
 
 
 
 
 
 
 
 
 
Futures contracts
Receivable from brokers, dealers and clearing organizations
 
86,393

 
31,800

 
86,100

 
31,906

Gross derivative assets/liabilities, before netting
 
$
111,977

 
 
 
$
109,662

 
 
Less: Legally enforceable master netting agreements
 
 
 
 
 
 
 
 
Exchange traded (3)
 
(92,572
)
 
 
 
(94,948
)
 
 
Bi-lateral over-the-counter (4)
 

 
 
 
(154
)
 
 
Net amounts per Consolidated Statement of Financial Condition (5)
 
$
19,405

 
 
 
$
14,560

 
 
(1) 
The foreign currency forward contract represents a net investment hedge and is designated as a hedging instrument.
(2) 
The equity forward contract represents a liability to deliver shares of Bats common stock to General Atlantic as described in Footnote 8 "Investments".
(3) 
Exchange traded instruments comprise futures contracts.
(4) 
Bi-lateral over-the-counter instruments comprise swaps and forward contracts.
(5) 
The Company has not received or pledged additional collateral under master netting agreements and or other credit support agreements that is eligible to be offset beyond what is offset in the Consolidated Statements of Financial Condition.
The fair value of listed options and forward contracts in the tables above are classified as Level 1 and Level 2 in the fair value hierarchy, respectively. The fair value of futures contracts and swaps in the tables above are classified as Level 1 and Level 2 in the fair value hierarchy, respectively.

21


KCG HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
(Unaudited)



The following table summarizes the gains and losses included in the Consolidated Statements of Operations for the three months ended March 31, 2017 and 2016.
 
 
 
 
Gain (Loss) Recognized
 
 
Financial Statements
 
For the three months ended March 31,
 
 
Location
 
2017
 
2016
Derivative instruments not designated as hedging instruments:
 
 
 
 
 
 
Foreign currency
 
 
 
 
 
 
Futures contracts
 
Trading revenues, net
 
$
2,712

 
$
312

Equity
 
 
 
 
 
 
  Futures contracts
 
Trading revenues, net
 
(7,998
)
 
8,922

  Swap contracts
 
Trading revenues, net
 
(795
)
 
1,886

  Listed options
 
Trading revenues, net
 
(24
)
 
3,871

Fixed income
 
 
 
 
 
 
  Futures contracts
 
Trading revenues, net
 
(118
)
 
6,833

Commodity
 
 
 
 
 
 
  Futures contracts
 
Trading revenues, net
 
3,750

 
6,966

 
 
 
 
$
(2,473
)
 
$
28,790

Derivative instruments designated as hedging instruments:
 
 
 
 
 
 
Foreign exchange - forward contract
 
Accumulated other comprehensive (loss) income
 
$
(389
)
 
$
(149
)
6. Collateralized Transactions
The Company receives financial instruments as collateral in connection with securities borrowed and financial instruments purchased under agreements to resell. Such financial instruments generally consist of equities, corporate obligations and obligations of the U.S. government, but may also include obligations of federal agencies, foreign governments and convertible securities. In most cases the Company is permitted to deliver or repledge these financial instruments in connection with securities lending, other secured financings or for meeting settlement obligations.
The table below presents financial instruments at fair value received as collateral related to Securities borrowed or Receivable from brokers, dealers and clearing organizations on the Consolidated Statements of Financial Condition that were permitted to be delivered or repledged and that were delivered or repledged by the Company as well as the fair value of financial instruments which could be further repledged by the receiving party (in thousands):
 
March 31,
2017
 
December 31,
2016
Collateral permitted to be delivered or repledged
$
1,623,886

 
$
1,634,979

Collateral that was delivered or repledged
1,577,554

 
1,550,755

Collateral permitted to be further repledged by the receiving counterparty
151,534

 
41,730

In order to finance securities positions, the Company also pledges financial instruments that it owns to counterparties who, in turn, are permitted to deliver or repledge them. Under these transactions, the Company pledges certain financial instruments owned to collateralize repurchase agreements and other secured financings. Repurchase agreements and other secured financings are short-term and mature within one year. Financial instruments owned and pledged to counterparties that have the right to sell or repledge such financial instruments primarily consist of equities. Financial instruments owned and pledged to counterparties that do not have the right to sell or repledge such financial instruments consist of equities, corporate obligations and obligations of the U.S. government, but may also include obligations of federal agencies, foreign governments and convertible securities.

22


KCG HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
(Unaudited)



The table below presents information about assets pledged by the Company (in thousands):
 
March 31,
2017
 
December 31,
2016
Financial instruments owned, at fair value, pledged to counterparties that have the right to deliver or repledge
$
368,736

 
$
314,720

Financial instruments owned, at fair value, pledged to counterparties that do not have the right to deliver or repledge
1,204,165

 
1,291,979

The table below presents the gross carrying value of Securities loaned, Financial instruments sold under agreements to repurchase and other collateralized financings by class of collateral pledged (in thousands):
March 31, 2017
 
 
 
Financial instruments sold under agreements to repurchase
 
Other collateralized financings
Asset Class
 
Securities Loaned
 
 
Equities
 
$
459,533

 
$
940,000

 
$
50,000

U.S. government obligations
 

 
12,584

 

Total
 
$
459,533

 
$
952,584

 
$
50,000

December 31, 2016
 
 
 
Financial instruments sold under agreements to repurchase
 
Other collateralized financings
Asset Class
 
Securities Loaned
 
 
Equities
 
$
369,168

 
$
989,812

 
$
76,176

U.S. government obligations
 

 
12,775

 

Corporate debt
 
3,463

 
25,188

 
23,824

Total
 
$
372,631

 
$
1,027,775

 
$
100,000

The Company may enter into master netting agreements and collateral arrangements with counterparties in order to manage its exposure to credit risk associated with securities financing transactions. Such transactions are generally executed under standard industry agreements, including, but not limited to, master securities lending agreements (securities lending transactions) and master repurchase agreements (repurchase transactions). Master agreements provide protection in bankruptcy in certain circumstances and, where legally enforceable, enable receivables and payables with the same counterparty to be settled or otherwise eliminated by applying amounts due against all or a portion of an amount due from the counterparty or a third party. The Company may also enter into bilateral trading agreements and other customer agreements that provide for the netting of receivables and payables with a given counterparty as a single net obligation.
In the event of a counterparty’s default, provisions of the master agreement permit acceleration and termination of all outstanding transactions covered by the agreement such that a single amount is owed by, or to, the non-defaulting party. Any collateral posted can be applied to the net obligations, with any excess returned and the collateralized party has a right to liquidate the collateral. Any residual claim after netting is treated as an unsecured claim in bankruptcy court.
The Company is also a party to clearing agreements with various central clearing parties. Under these arrangements, the central clearing counterparty facilitates settlement between counterparties based on the net payable owed or receivable due and, with respect to daily settlement, cash is generally only required to be deposited to the extent of the net amount. In the event of default, a net termination amount is determined based on the market values of all outstanding positions and the clearing organization or clearing member provides for the liquidation and settlement of the net termination amount among all counterparties to the open repurchase and/or securities lending transactions.

23


KCG HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
(Unaudited)



The gross amounts of assets and liabilities subject to netting and gross amounts offset in the Consolidated Statements of Financial Condition were as follows (in thousands):
 
March 31, 2017
Gross Amounts Recognized
 
Gross Amounts Offset in the Statements of Financial Condition
 
Net Amounts Presented in the Statements of Financial Condition
 
Gross Amounts Not Offset in the Statement of Financial Condition
 
Net Amount
 
Available Collateral(1)
 
Counterparty Netting(2)
 
 
Assets
 
 
 
 
 
 
 
 
 
 
 
 
Securities borrowed
$
1,594,442

 
$

 
$
1,594,442

 
$
1,537,957

 
$
6,225

 
$
50,260

 
Receivable from brokers, dealers and clearing organizations (3)
13,735

 

 
13,735

 
13,717

 
2

 
16

 
Total assets
$
1,608,177

 
$

 
$
1,608,177

 
$
1,551,674

 
$
6,227

 
$
50,276

 
Liabilities
 
 
 
 
 
 
 
 
 
 
 
 
Securities loaned
$
459,533

 
$

 
$
459,533

 
$
446,050

 
$
6,225

 
$
7,258

 
Financial instruments sold under agreements to repurchase
952,584

 

 
952,584

 
952,582

 
2

 

 
Other collateralized financings
50,000

 

 
50,000

 
50,000

 

 

 
Total liabilities
$
1,462,117

 
$

 
$
1,462,117

 
$
1,448,632

 
$
6,227

 
$
7,258

(1) 
Includes securities received or delivered under collateral arrangements with counterparties that could be liquidated in the event of a counterparty default and thus offset against a counterparty's rights and obligations under the respective repurchase agreements or securities borrowing or lending arrangements.
(2) 
Under master netting agreements with its counterparties, the Company has the legal right of offset with a counterparty, which incorporates all of the counterparty's outstanding rights and obligations under the arrangement. These balances reflect additional credit risk mitigation that is available by counterparty in the event of a counterparty's default, but which are not netted in the Consolidated Statement of Financial Condition because other netting provisions under U.S. GAAP are not met.
(3) 
Represents financial instruments purchased under agreement to resell.
 
December 31, 2016
Gross Amounts Recognized
 
Gross Amounts Offset in the Statements of Financial Condition
 
Net Amounts Presented in the Statements of Financial Condition
 
Gross Amounts Not Offset in the Statement of Financial Condition
 
Net Amount
 
Available Collateral(1)
 
Counterparty Netting(2)
 
 
Assets
 
 
 
 
 
 
 
 
 
 
 
 
Securities borrowed
$
1,688,222

 
$

 
$
1,688,222

 
$
1,623,281

 
$
4,581

 
$
60,360

 
Receivable from brokers, dealers and clearing organizations (3)
21,832

 

 
21,832

 
21,797

 

 
35

 
Total assets
$
1,710,054

 
$

 
$
1,710,054

 
$
1,645,078

 
$
4,581

 
$
60,395

 
Liabilities
 
 
 
 
 
 
 
 
 
 
 
 
Securities loaned
$
372,631

 
$

 
$
372,631

 
$
358,023

 
$
4,581

 
$
10,027

 
Financial instruments sold under agreements to repurchase
1,027,775

 

 
1,027,775

 
1,027,775

 

 

 
Other collateralized financings
100,000

 

 
100,000

 
100,000

 

 

 
Total liabilities
$
1,500,406

 
$

 
$
1,500,406

 
$
1,485,798

 
$
4,581

 
$
10,027

(1) 
Includes securities received or delivered under collateral arrangements with counterparties that could be liquidated in the event of a counterparty default and thus offset against a counterparty's rights and obligations under the respective repurchase agreements or securities borrowing or lending arrangements.
(2) 
Under master netting agreements with its counterparties, the Company has the legal right of offset with a counterparty, which incorporates all of the counterparty's outstanding rights and obligations under the arrangement. These balances reflect additional credit risk mitigation that is available by a counterparty in the event of a counterparty's default, but which are not netted in the Consolidated Statement of Financial Condition because other netting provisions under U.S. GAAP are not met.
(3) 
Represents financial instruments purchased under agreement to resell.
See Footnote 5 "Derivative Financial Instruments" for information related to the offsetting of derivatives in the Company's Consolidated Financial Statements.

24


KCG HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
(Unaudited)



Maturities of Securities loaned, Financial instruments sold under agreements to repurchase and other collateralized financings are provided in the table below (in thousands):
As of March 31, 2017
Overnight
 
0 - 30 days
 
31 - 60 days
 
61 - 90 days
 
Total
Securities loaned
$
459,533

 
$

 
$

 
$

 
$
459,533

Financial instruments sold under agreements to repurchase
12,584

 
335,000

 
365,000

 
240,000

 
952,584

Other collateralized financings

 
50,000

 

 

 
50,000

Total
$
472,117

 
$
385,000

 
$
365,000

 
$
240,000

 
$
1,462,117

As of December 31, 2016
Overnight
 
0 - 30 days
 
31 - 60 days
 
61 - 90 days
 
Total
Securities loaned
$
372,631

 
$

 
$

 
$

 
$
372,631

Other

 
100,000

 

 

 
100,000

Financial instruments sold under agreements to repurchase
12,775

 
410,000

 
465,000

 
140,000

 
1,027,775

Total
$
385,406

 
$
510,000

 
$
465,000

 
$
140,000

 
$
1,500,406

7. Receivable from and Payable to Brokers, Dealers and Clearing Organizations
Amounts receivable from and payable to brokers, dealers and clearing organizations consist of the following (in thousands):
 
March 31,
2017
 
December 31,
2016
Receivable:
 
 
 
Clearing organizations and other
$
575,544

 
$
619,425

Financial instruments purchased under agreement to resell
13,735

 
21,832

Securities failed to deliver
212,399

 
191,528

Total receivable
$
801,678

 
$
832,785

Payable:
 
 
 
Clearing organizations and other
$
433,164

 
$
458,341

Securities failed to receive
62,089

 
60,559

Total payable
$
495,253

 
$
518,900

Management believes that the carrying value of amounts receivable from and payable to brokers, dealers and clearing organizations approximates fair value since they are short term in nature.
8. Investments
Investments primarily comprise strategic investments and deferred compensation investments. Investments consist of the following (in thousands): 
 
March 31,
2017
 
December 31,
2016
Strategic investments:
 
 
 
Investments accounted for under the equity method
$
17,313

 
$
16,707

Investments held at fair value
2,379

 
9,198

Investments held at cost, less impairment
2,790

 
2,789

Total strategic investments
22,482

 
28,694

Other investments
2,234

 
2,285

Total investments
$
24,716

 
$
30,979

For the three months ended March 31, 2017 and 2016, the Company recorded income of approximately $48 thousand and $4.8 million, respectively, related to Investments accounted for under the equity method of accounting, which is recorded within Investment income and other, net in the Consolidated Statements of Operations. The Company's investments accounted for under the equity method are considered to be related parties. See Footnote 11 "Related Parties".

25


KCG HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
(Unaudited)



In the first quarter of 2016, one of the Company's investments held at adjusted cost, less impairment made a distribution to its owners, including the Company. As a result of this distribution, the Company adjusted the investment's carrying value and recognized a pre-tax gain of $2.3 million, which is included in Investment income and other, net on the Consolidated Statements of Operations for the three months ended March 31, 2016.
Investments held at fair value are accounted for as available for sale securities and any unrealized gains or losses are recorded net of tax in Other comprehensive (loss) income.
Bats/General Atlantic Transactions
In the fourth quarter 2016, the Company sold approximately 2.0 million shares of common stock of Bats in the open market (“open market transactions”) and sold an additional 2.2 million shares of common stock of Bats in a block sale ("block sale").
In November 2016 KCG entered into a purchase agreement with GA-GTCO Interholdco, LLC (“General Atlantic” or “GA”) to exchange approximately 8.9 million shares of its Bats common stock for i) GA’s 18.7 million shares of KCG Class A Common Stock and, ii) 8.1 million Warrants (the “Swap Transaction”).
The Company’s 6.875% Indenture (as defined below) contains covenants that limit the Company’s ability to repurchase shares of KCG Class A Common Stock and Warrants.
Substantially all of the exchange was completed in November 2016, however as a result of these limitations, and as contemplated in the agreement with GA, the Company could not finalize the repurchase of approximately 1.1 million Warrants, and therefore retained approximately 94,000 common shares of Bats at December 31, 2016. The $2.9 million value of these remaining Bats shares was recorded as a receivable from GA within Other assets and a related $2.9 million liability to GA was recorded within Accrued expenses and other liabilities on the Company’s December 31, 2016 Consolidated Statement of Financial Condition. The exchange was completed in January 2017.
Pursuant to the terms of the Swap Transaction, the Company paid transaction fees of $2.9 million to Jefferies LLC, comprising half due from the Company and the other half on behalf of GA. The settlement of the portion paid by the Company on behalf of GA was completed by KCG retaining Bats common stock with a fair value of $1.4 million at the time of the Swap Transaction, or approximately 46,000 shares of the aforementioned 94,000 shares of Bats shares owed to GA. The remaining 48,000 shares owed to GA were considered to be a derivative for financial reporting purposes as of December 31, 2016. See Footnote 5 "Derivative Financial Instruments".
As a result of the open market transactions, block sale and Swap Transaction, the Company sold approximately 13.0 million shares of Bats, and the Company’s total holdings were reduced to approximately 206,000 shares or less than 0.5% of total shares of Bats common stock outstanding. The Company believes that it no longer has significant influence over Bats, and as a result, in November 2016, the Company ceased to account for its remaining interest in Bats under the equity method.
The approximately 206,000 shares of Bats remaining as an investment had a fair value of $6.9 million at December 31, 2016 and were classified as available-for-sale securities (“AFS”), which was recorded within Investments on the Company’s Consolidated Statements of Financial Condition as of December 31, 2016.
In the first quarter of 2017, the Company sold its remaining shares of Bats and recorded a pre-tax gain of $4.8 million which is included in Investment income and other, net on the Consolidated Statements of Operations for the three months ended March 31, 2017. As of March 31, 2017, the Company does not own any shares of Bats.
9. Goodwill and Intangible Assets
Goodwill and intangible assets with indefinite lives are assessed for impairment annually or when events indicate that the amounts may be impaired. The Company assesses goodwill for impairment at the reporting unit level. The Company’s reporting units are the components of its business segments for which discrete financial information is available and is regularly reviewed by the Company’s management. As part of the assessment for impairment, the Company considers the cash flows of the respective reporting unit and assesses the fair value of the respective reporting unit as well as the overall market value of the Company compared to its net book value. The assessment of fair value of the reporting units is principally performed using a discounted cash flow methodology with a risk-adjusted weighted average cost of equity which the Company believes to be the most reliable indicator of the fair values of its respective reporting units. The Company also assesses the fair value of each reporting unit based upon its estimated market value and assesses the Company’s overall market value based upon the market price of KCG Class A Common Stock.

26


KCG HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
(Unaudited)



Intangible assets are assessed for recoverability when events or changes in circumstances indicate that the carrying amount of the asset or asset group may not be recoverable. The Company assesses intangible assets for impairment at the “asset group” level which is the lowest level for which identifiable cash flows are largely independent of the cash flows of other groups of assets and liabilities. As part of the assessment for impairment, the Company considers the cash flows of the respective asset group and assesses the fair value of the respective asset group. Step one of the impairment assessment for intangibles is performed using undiscounted cash flow models, which indicates whether the future cash flows of the asset group are sufficient to recover the book value of such asset group. When an asset is not considered to be recoverable, step two of the impairment assessment is performed using a discounted cash flow methodology with a risk-adjusted weighted average cost of equity to determine the fair value of the intangible asset group. In cases where amortizable intangible assets and goodwill are assessed for impairment at the same time, the amortizable intangibles are assessed for impairment prior to goodwill being assessed.
No events occurred in the three months ended March 31, 2017 or 2016 that would indicate that the carrying amounts of the Company’s goodwill or intangible assets may not be recoverable.
As detailed in Footnote 3 “Assets of Business Held for Sale & Sales of Businesses”, in late 2015, the Company conducted a strategic review of its businesses and determined that one of its businesses was no longer considered core to its strategy and the Company sought the opportunity to exit or divest this business. The estimated fair value of intangibles related to a business held for sale of $8.2 million as of December 31, 2016 was reported within Assets of business held for sale on the Consolidated Statements of Financial Condition. These intangibles, which comprise a technology platform, have been reclassified to Intangible Assets as of March 31, 2017 as it has been determined that such assets of the business will not be sold.
As of both March 31, 2017 and December 31, 2016, $16.4 million of goodwill was recorded within the Market Making segment.
Intangible assets with definite useful lives are amortized over their remaining estimated useful lives, the majority of which have been determined to range from one to six years. The weighted average remaining life of the Company’s intangible assets with definite useful lives at both March 31, 2017 and December 31, 2016 was approximately two years.
The following tables summarize the Company’s Intangible assets, net of accumulated amortization by segment and type (in thousands):
 
March 31,
2017
 
December 31,
2016
Market Making
 
 
 
Technology
$
38,759

 
$
39,536

Trading rights
7,028

 
7,027

Total
45,787

 
46,563

Global Execution Services
 
 
 
Technology
20,033

 
20,694

Customer relationships
7,583

 
7,944

Trade names
625

 
650

Total
28,241

 
29,288

Corporate and Other
 
 
 
   Technology (1)
16,418

 
8,084

Total
$
90,446

 
$
83,935

(1) 
Excluded from the December 31, 2016 balance is $8.2 million of intangibles related to a business which met the requirements to be considered held for sale. As noted above and in Footnote 3 "Assets of Business Held for Sale & Sales of Businesses", such amounts were included in Assets of business held for sale at December 31, 2016, however, such intangibles were no longer considered to be held for sale at March 31, 2017 and are therefore included above at March 31, 2017.

27


KCG HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
(Unaudited)



 
 
March 31,
2017
 
December 31,
2016
Technology (1)
Gross carrying amount
$
183,567

 
$
157,188

 
Accumulated amortization
(108,347
)
 
(88,874
)
 
Net carrying amount
75,220

 
68,314

Trading rights (2)
Gross carrying amount
7,509

 
7,509

 
Accumulated amortization
(491
)
 
(482
)
 
Net carrying amount
7,018

 
7,027

Customer relationships (3)
Gross carrying amount
13,000

 
13,000

 
Accumulated amortization
(5,417
)
 
(5,056
)
 
Net carrying amount
7,583

 
7,944

Trade names (4)
Gross carrying amount
1,000

 
1,000

 
Accumulated amortization
(375
)
 
(350
)
 
Net carrying amount
625

 
650

Total
Gross carrying amount
205,076

 
178,697

 
Accumulated amortization
(114,630
)
 
(94,762
)
 
Net carrying amount
$
90,446

 
$
83,935

(1) 
The weighted average remaining life for technology, including capitalized internal use software, was approximately two years as of both March 31, 2017 and December 31, 2016. Excluded from the December 31, 2016 balance is $8.2 million of technology assets related to Assets of businesses held for sale. As noted above and in Footnote 3 "Assets of Business Held for Sale & Sales of Businesses", these assets are included in Assets of businesses held for sale at December 31, 2016.
(2) 
Trading rights provide the Company with the rights to trade on certain exchanges. The weighted average remaining life of trading rights with definite useful lives was approximately 3 and 4 years as of March 31, 2017 and December 31, 2016, respectively. As of March 31, 2017 and December 31, 2016, $6.9 million of trading rights had indefinite useful lives.
(3) 
Customer relationships relate to KCG BondPoint. The weighted average remaining life was approximately 5 and 6 years as of March 31, 2017 and December 31, 2016, respectively. Lives may be reduced depending upon actual retention rates.
(4) 
Trade names relate to KCG BondPoint. The weighted average remaining life was approximately 6 and 7 years as of March 31, 2017 and December 31, 2016, respectively.
The following table summarizes the Company’s amortization expense relating to Intangible assets (in thousands):
 
For the three months ended March 31,