11. Financial Assets and Liabilities

Financial Instruments Measured at Fair Value

The fair value of equities, options, on the run U.S. government obligations and exchange traded notes is estimated using recently executed transactions and market price quotations in active markets and are categorized as Level 1 with the exception of inactively traded equities and certain financial instruments noted in the preceding paragraph, which are categorized as Level 2. The Company’s corporate bonds, derivative contracts and other U.S. and non-U.S. government obligations have been categorized as Level 2. Fair value of the Company’s derivative contracts is based on the indicative prices obtained from broadly distributed bank and broker dealers, as well as management’s own analyses. The indicative prices have been independently validated through the Company’s risk management systems, which are designed to check prices with information independently obtained from exchanges and venues where such financial instruments are listed or to compare prices of similar instruments with similar maturities for listed financial futures in foreign exchange.

As of March 31, 2017, the Company began pricing certain financial instruments held for trading at fair value based on theoretical prices which can differ from quoted market prices. The theoretical prices reflect price adjustments primarily caused by the fact that the Company continuously prices its financial instruments based on all available information. This information includes prices for identical and near-identical positions, as well as the prices for securities underlying the Company’s positions, on other exchanges that are open after the exchange on which the financial instruments is traded closes. The Company validates that all price adjustments can be substantiated with market inputs and checks the theoretical prices independently. Consequently, such financial instruments are classified as Level 2. The Company concluded that this is a change in accounting estimate and no retrospective adjustments were necessary.

Fair value measurements for those items measured on a recurring basis are summarized below as of December 31, 2017:


	December 31, 2017
	Quoted Prices		Significant
	in Active		Other		Significant		Counterparty
	Markets for		Observable		Unobservable		and Cash
	Identical Assets		Inputs		Inputs		Collateral		Total Fair
(in thousands)	(Level 1)		(Level 2)		(Level 3)		Netting		Value
Assets
Financial instruments owned, at fair value:
Equity securities	$	758,596	$	1,167,995	$	—	$	—	$	1,926,591
U.S. and Non-U.S. government obligations		5,968		16,815		—		—		22,783
Corporate Bonds		—		60,975		—		—		60,975
Exchange traded notes		13,576		68,819		—		—		82,395
Currency forwards		—		2,045,487		—		(2,027,697)		17,790
Options		7,045		—		—		—		7,045
		785,185		3,360,091		—		(2,027,697)		2,117,579

Financial instruments owned, pledged as collateral:
Equity securities	$	410,670	$	175,581	$	—	$	—	$	586,251
U.S. and Non-U.S. government obligations		99		—		—		—		99
Exchange traded notes		82		8,611		—		—		8,693
		410,851		184,192		—		—		595,043

Other Assets
Equity investment	$	—	$	—	$	40,588	$	—	$	40,588
Exchange stock		1,952		—		—		—		1,952
Other(1)		—		55,824		—		—		55,824
		1,952		55,824		40,588		—		98,364

Liabilities
Financial instruments sold, not yet purchased, at fair value:
Equity securities	$	847,816	$	1,355,616	$	—	$	—	$	2,203,432
U.S. and Non-U.S. government obligations		18,940		12,481		—		—		31,421
Corporate Bonds		—		81,118		—		—		81,118
Exchange traded notes		1,514		54,248		—		—		55,762
Currency forwards		—		2,032,017		—		(2,024,991)		7,026
Options		5,839		—		—		—		5,839
	$	874,109	$	3,535,480	$	—	$	(2,024,991)	$	2,384,598

(1)

Other primarily consists of a $55.8 million receivable from Bats related to the sale of KCG Hotspot.

Fair value measurements for those items measured on a recurring basis are summarized below as of December 31, 2016:


	December 31, 2016
	Quoted
	Prices in
	Active		Significant
	Markets for		Other		Significant		Counterparty
	Identical		Observable		Unobservable		and Cash
	Assets		Inputs		Inputs		Collateral		Total Fair
(in thousands)	(Level 1)		(Level 2)		(Level 3)		Netting		Value
Assets
Financial instruments owned, at fair value:
Equity securities	$	1,597,049	$	31,988	$	—	$	—	$	1,629,037
Non-U.S. government obligations		—		10,765		—		—		10,765
Exchange traded notes		37,034		—		—		—		37,034
Currency forwards		—		1,147,261		—		(1,140,239)		7,022
Options		—		141		—		—		141
	$	1,634,083	$	1,190,155	$	—	$	(1,140,239)	$	1,683,999
Financial instruments owned, pledged as collateral:
Equity securities	$	128,202	$	—	$	—	$	—	$	128,202
Exchange traded notes		15,681		—		—		—		15,681
	$	143,883	$	—	$	—	$	—	$	143,883
Other Assets
Equity investment	$	—	$	—	$	36,031	$	—	$	36,031
Exchange stock		449		—		—		—		449
	$	449	$	—	$	36,031	$	—	$	36,480
Liabilities
Financial instruments sold, not yet purchased, at fair value:
Equity securities	$	1,323,693	$	6,638	$	—	$	—	$	1,330,331
Exchange traded notes		18,744		—		—		—		18,744
Currency forwards		—		1,009,038		—		(1,009,038)		—
Options		—		80		—		—		80
	$	1,342,437	$	1,015,756	$	—	$	(1,009,038)	$	1,349,155

On July 27, 2016, the Company purchased an additional minority investment (29.4%) in SBI Japannext Co., Ltd (“SBI Japannext”), a proprietary trading system based in Tokyo for $38.8 million in cash (“SBI Investment”), which increased the Company’s total minority investment in SBI Japannext to 29.9%.The Company elected the fair value option to account for this equity investment because it believes that fair value is the most relevant measurement attribute for this investment, as well as to reduce operational and accounting complexity. This investment has been categorized as Level 3, and the valuation process involved for Level 3 measurements is completed on a quarterly basis. The Company employs two valuation methodologies when determining the fair value of investments categorized as Level 3, market comparable analysis and discounted cash flow analysis. The market comparable analysis considers key financial inputs, recent public and private transactions and other available measures. The discounted cash flow analysis incorporates significant assumptions and judgments and the estimates of key inputs used in this methodology include the discount rate for the investment and assumed inputs used to calculate terminal values, such as price/earnings multiples. Upon completion of the valuations conducted using these methodologies, a weighting is ascribed to each method and to the ultimate fair value recorded for a particular investment. When determining the weighting ascribed to each valuation methodology, the Company considers, among other factors, the availability of direct market comparables, the applicability of a discounted cash flow analysis and the expected holding period.

As of December 31, 2017, the fair value of SBI Investment was determined using the discounted cash flow method, an income approach, with the discount rate of 15.0% applied to the cash flow forecasts. The Company also used a market approach based on 14x average price/earnings multiples of comparable companies to corroborate the income approach. The fair value of the SBI Investment at December 31, 2017 was determined by taking the weighted average of enterprise valuations based on discounted cash flow on projected income from the next five years, the implied enterprise valuations on comparable companies, and the implied enterprise valuations on comparable transactions. The fair value measurement is highly sensitive to significant changes in the unobservable inputs and significant increases (decreases) in discount rate or decreases (increases) in price/earnings multiples would result in a significantly lower (higher) fair value measurement. Changes in the fair value of the SBI Investment are reflected in other, net in the consolidated statements of comprehensive income.

There were no transfers of financial instruments between levels during the years ended December 31, 2017 and 2016.

Receivable from Bats Global Markets, Inc. (“Bats”)

In March 2015, KCG sold KCG Hotspot, an institutional spot foreign exchange electronic communications networks (“ECN”), to Bats, which is now a subsidiary of CBOE Holdings, Inc. KCG and Bats agreed to share certain tax benefits, which as of December 31, 2017 comprise a $50.0 million payment and an annual payment of up to $6.6 million, both of which are due in April 2018. The $6.8 million annual payment is contingent on Bats (and 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. The remaining additional potential payments of $56.8 million are recorded at a fair value of $55.8 million in other assets on the consolidated statements of financial condition as of December 31, 2017.

Financial Instruments Not Measured at Fair Value

The table below presents the carrying value, fair value and fair value hierarchy category of certain financial instruments that are not measured at fair value on the consolidated statement of financial condition. The table below excludes non-financial assets and liabilities. The carrying value of financial instruments not measured at fair value categorized in the fair value hierarchy as Level 1 and Level 2 approximates fair value due to the relatively short-term nature of the underlying assets. The fair value of the Company’s long-term borrowings is categorized as Level 2 in the fair value hierarchy, which is based on quoted prices from the market.

Financial assets and liabilities not measured at fair value as of December 31, 2017:


	December 31, 2017
						Quoted Prices		Significant
						in Active		Other		Significant
						Markets for		Observable		Unobservable
						Identical Assets		Inputs		Inputs
		Carrying Value		Fair Value		(Level 1)		(Level 2)		(Level 3)
Assets
Cash and cash equivalents	$	532,887	$	532,887	$	532,887	$	—	$	—

Securities borrowed	$	1,471,172	$	1,471,172	$	—	$	1,471,172	$	—

Receivables from broker dealers and clearing organizations		972,018		972,018		36,513		935,505		—

Total Assets	$	2,976,077	$	2,976,077	$	569,400	$	2,406,677	$	—

Liabilities
Short-term borrowings	$	27,883	$	27,883	$	—	$	27,883	$	—

Long-term borrowings	$	1,388,548	$	1,465,489	$	—	$	1,465,489	$	—

Securities loaned	$	754,687	$	754,687	$	—	$	754,687	$	—

Securities sold under agreements to repurchase	$	390,642	$	390,642	$	—	$	390,642	$	—

Payables to broker dealer and clearing organizations		716,205		716,205		2,925		713,280		—

Total Liabilities	$	3,277,965	$	3,354,906	$	2,925	$	3,351,981	$	—

Financial assets and liabilities not measured at fair value as of December 31, 2016:


	December 31, 2016
						Quoted Prices		Significant
						in Active		Other		Significant
						Markets for		Observable		Unobservable
						Identical Assets		Inputs		Inputs
		Carrying Value		Fair Value		(Level 1)		(Level 2)		(Level 3)
Assets
Cash and cash equivalents	$	181,415	$	181,415	$	181,415	$	—	$	—

Securities borrowed	$	220,005	$	220,005	$	—	$	220,005	$	—

Receivables from broker dealers and clearing organizations		448,728		972,018		—		972,018		—

Total Assets	$	850,148	$	1,373,438	$	181,415	$	1,192,023	$	0

Liabilities
Short-term borrowings	$	25,000	$	25,000	$	—	$	25,000	$	—

Long-term borrowings	$	564,957	$	564,957	$	—	$	564,957	$	—

Securities loaned	$	222,203	$	222,203	$	—	$	222,203	$	—

Payables to broker dealer and clearing organizations		695,978		695,978		—		695,978		—

Total Liabilities	$	1,508,138	$	1,508,138	$	—	$	1,508,138	$	—

The following presents the changes in Level 3 financial instruments measured at fair value on a recurring basis:


	Year Ended December 31, 2017
													Change in Net
													Unrealized Gains
													/ (Losses) on
													Investments
	Balance at				Total Realized		Net Transfers				Balance at		still held at
	December 31,				and Unrealized		into (out of)				December 31		December 31
(in thousands)	2016		Purchases		Gains / (Losses)		Level 3		Settlement		2017		2017
Assets
Other assets:
Equity investment	$	36,031	$	—	$	4,557	$	—	$	—	$	40,588	$	4,557
Other		—		3,000		—		—		(3,000)		—		—
Total	$	36,031	$	3,000	$	4,557	$	—	$	(3,000)	$	40,588	$	4,557


		Year Ended December 31, 2016
											Change in Net
											Unrealized Gains
											/ (Losses) on
											Investments
	Balance at				Total Realized		Net Transfers		Balance at		still held at
	December 31,				and Unrealized		into (out of)		December 31		December 31
(in thousands)	2015		Purchases		Gains / (Losses)		Level 3		2016		2016
Assets
Other assets:
Equity investment	$	—	$	38,754	$	(3,117)	$	394	$	36,031	$	(3,117)
Total	$	—	$	38,754	$	(3,117)	$	394	$	36,031	$	(3,117)

Offsetting of Financial Assets and Liabilities

The Company does not net securities borrowed and securities loaned, or securities purchased under agreements to resell and securities sold under agreements to repurchase. These financial instruments are presented on a gross basis in the consolidated statements of financial condition. In the tables below, the amounts of financial instruments owned that are not offset in the consolidated statements of financial condition, but could be netted against financial liabilities with specific counterparties under legally enforceable master netting agreements in the event of default, are presented to provide financial statement readers with the Company’s estimate of its net exposure to counterparties for these financial instruments.

The following tables set forth the gross and net presentation of certain financial assets and financial liabilities as of December 31, 2017 and 2016.


	December 31, 2017

					Net Amounts of
			Gross Amounts		Assets Presented
			Offset in the		in the		Gross Amounts Not Offset In the
	Gross Amounts		Consolidated		Consolidated		Statement of Financial Condition
	of Recognized		Statement of		Statement of		Financial		Cash Collateral
(in thousands)	Assets		Financial Condition		Financial Condition		Instruments		Received		Net Amount
Offsetting of Financial Assets:
Securities borrowed	$	1,471,172	$	—	$	1,471,172	$	(1,418,672)	$	(13,318)	$	39,182
Trading assets, at fair value:
Currency forwards		2,045,487		(2,027,697)		17,790		—		—		17,790
Options		7,045		—		7,045		(45)		—		7,000
Total	$	3,523,704	$	(2,027,697)	$	1,496,007	$	(1,418,717)	$	(13,318)	$	63,972



					Net Amounts of
			Gross Amounts		Liabilities Presented
			Offset in the		in the		Gross Amounts Not Offset In the
	Gross Amounts		Consolidated		Consolidated		Statement of Financial Condition
	of Recognized		Statement of		Statement of		Financial		Cash Collateral
	Liabilities		Financial Condition		Financial Condition		Instruments		Pledged		Net Amount
Offsetting of Financial Liabilities:
Securities loaned	$	754,687	$	—	$	754,687	$	(737,731)	$	(10,776)	$	6,180
Securities sold under agreements to repurchase		390,642		—		390,642		(390,642)		—		—
Trading liabilities, at fair value:
Currency forwards		2,032,017		(2,024,991)		7,026		—				7,026
Options		5,839		—		5,839		(56)		—		5,783
Total	$	3,183,185	$	(2,024,991)	$	1,158,194	$	(1,128,429)	$	(10,776)	$	18,989


	December 31, 2016

					Net Amounts of
			Gross Amounts		Assets Presented
			Offset in the		in the		Gross Amounts Not Offset In the
	Gross Amounts		Consolidated		Consolidated		Statement of Financial Condition
	of Recognized		Statement of		Statement of		Financial		Cash Collateral
(in thousands)	Assets		Financial Condition		Financial Condition		Instruments		Received		Net Amount
Offsetting of Financial Assets:
Securities borrowed	$	220,005	$	—	$	220,005	$	(216,778)	$	(248)	$	2,979
Trading assets, at fair value:
Currency forwards		1,147,261		(1,140,239)		7,022		—		—		7,022
Options		141		—		141		(80)		(13)		48
Total	$	1,367,407	$	(1,140,239)	$	227,168	$	(216,858)	$	(261)	$	10,049



					Net Amounts of
					Liabilities
			Gross Amounts		Presented		Gross Amounts Not Offset In the
			Offset in the		in the		Consolidated
	Gross Amounts		Consolidated		Consolidated		Statement of Financial Condition
	of Recognized		Statement of		Statement of		Financial		Cash Collateral
(in thousands)	Liabilities		Financial Condition		Financial Condition		Instruments		Pledged		Net Amount
Offsetting of Financial Liabilities:
Securities loaned	$	222,203	$	—	$	222,203	$	(221,792)	$	—	$	411
Trading liabilities, at fair value:
Currency forwards		1,009,038		(1,009,038)		—		—		—		—
Options		80		—		80		(80)		—		—
Total	$	1,231,321	$	(1,009,038)	$	222,283	$	(221,872)	$	—	$	411

The following table presents gross obligations for securities lending transactions by remaining contractual maturity and the class of collateral pledged.


		December 31, 2017
		Remaining Contractual Maturity
	Overnight and		Less than		30 - 60		61 - 90
(in thousands)	Continuous		30 days		days		Days		Total

Repurchase agreements:
Equity securities	$	—	$	100,000	$	90,000	$	200,000	$	390,000
U.S. and Non-U.S. government obligations		642		—		—		—		642
Total	$	642	$	100,000	$	90,000	$	200,000	$	390,642

Securities lending transactions:
Equity securities	$	754,687	$	—	$	—	$	—	$	754,687
Total	$	754,687	$	—	$	—	$	—	$	754,687


		December 31, 2016
		Remaining Contractual Maturity
	Overnight and		Less than		30 - 60		61 - 90
(in thousands)	Continuous		30 days		days		Days		Total

Repurchase agreements:
Equity securities	$	222,203	$	—	$	—	$	—	$	222,203
Total	$	222,203	$	—	$	—	$	—	$	222,203