Regulatory questions hang over U.S. exchange results

NEW YORK/CHICAGO Tue Feb 2, 2010 2:52pm EST

Trader Randall Borglin works in the S&P 500 Pit at the Chicago Mercantile Exchange July 23, 2009. REUTERS/John Gress

Trader Randall Borglin works in the S&P 500 Pit at the Chicago Mercantile Exchange July 23, 2009.

Credit: Reuters/John Gress

NEW YORK/CHICAGO (Reuters) - Exactly what a slew of new regulations could mean for major U.S. exchanges looms as the companies report quarterly results this week and next.

Despite broad consensus on the 2010 trading volume outlook -- with analysts expecting futures trading to rise, and equities trading to decline -- there is far less certainty on the regulatory front.

The possible rule changes are, in general, expected to play into the hands of futures exchange operators CME Group Inc (CME.O) and IntercontinentalExchange Inc (ICE.N), as well as equities-focused operators NYSE Euronext NYX.N and Nasdaq OMX (NDAQ.O), by forcing more trading onto regulated, transparent markets.

But details on more possible changes that came to light last month raise additional questions: President Barack Obama's plan to limit bank proprietary trading; the Securities and Exchange Commission's market structure study, with its focus on high-frequency trading; and the Commodity Futures Trading Commission's planned energy market position limits.

A fourth issue, involving upstart exchange ELX Futures, put "fungibility" of futures contracts center-stage last week, and has the long-shot potential to harm CME Group, analysts said.

Growing uncertainty has undercut exchange shares, with the Dow Jones Global Exchange index .DJGEX down 10 percent in January versus a 3.5 percent drop on the Dow Jones industrial average .DJI.

CME Group dropped 14.6 percent in that time, despite a 19 percent increase in trading, a metric that typically helps the company's shares because more trading means higher revenue.

While trading volumes are key to earnings results, the overall regulatory and political push to make U.S. and European markets safer after the biggest financial crisis since the Great Depression will figure large in the outlook.

"On the regulatory front for exchanges, they're in a reasonably good position in that they have a free call option -- things will either stay the same or they'll get better," said Alexander Yavorsky, senior analyst at Moody's, noting CME Group's battle with privately owned ELX might be an exception.

The CFTC last month rejected CME Group's decision to bar traders from easily moving Treasury futures positions from ELX.

CME Group now needs to offer a more compelling defense. In the unlikely event it fails to do so, the Chicago-based derivatives giant risks diminishing its ability to exclusively trade and clear its own products, known as non-fungibility.

"The voices calling for fungibility are growing louder, so anything that pushes you even a millimeter in that direction is not a very good thing from CME's perspective," said Yavorsky.

"If there were to be a death by a thousand cuts, this is maybe cut two."

EYES ON WASHINGTON

While the CFTC's plan to curb energy market speculation had little impact on exchange shares, Obama's proposed crackdown on bank risk taking hammered the shares and raised questions about long-term liquidity, volumes, and the predictability of market rules following the financial crisis.

"There's no silver bullet when there's populist concerns in Washington impacting the stock, but hopefully (exchange) management will be explaining how really difficult it will be to implement some of these things," said Niamh Alexander, analyst at Keefe, Bruyette & Woods.

Of the four companies, only ICE is expected to report per-share profit growth in the fourth quarter, according to Thomson Reuters I/B/E/S.

Although overall average derivatives volume leveled off in the quarter, ICE recorded a 13 percent bounce from the previous year while larger rival CME Group saw trading sag 3 percent.

Average cash equities volumes plunged 21 percent in the fourth quarter of last year, compared with the height of the market crisis at the end of 2008. Obama's surprise bank plan jolted markets and boosted January volume, albeit temporarily.

Analysts still mostly expect flat-to-lower cash equities volume this year, with Barclays Capital's Roger Freeman forecasting a 7 percent drop due to an expected decline in

volatility and less interest in low-priced financial shares.

Freeman wrote in a note he expects a 12 percent rise in futures trading. Sandler O'Neill analyst Richard Repetto said futures volumes would likely rise this year because uncertainty and price volatility require people to hedge more.

NYSE Euronext and Nasdaq OMX, both transatlantic equities and derivatives exchange operators, each derive less than 10 percent of revenue from U.S. cash equities. Revenue from listings and data partly relies on healthy equity trading.

(Reporting by Jonathan Spicer and Ann Saphir, editing by Matthew Lewis)