Exchanges doing robust business, but shares droop
NEW YORK (Reuters) - The major financial exchanges have spent much of the last year acquiring smaller rivals, both in the United States and overseas, in a continuing wave of industry consolidation designed to shore up their market dominance.
But while many of them are reporting robust profits and record trading volumes, shares of the major exchange operators have fallen significantly so far in 2008. The NYSE Euronext Inc (NYX.N), NASDAQ OMX Group (NDAQ.O) and CME Group Inc CME.N have all lost more than 22 percent, underperforming the KBW Capital Markets index .KSX, which includes exchanges, which is down 16 percent for the year.
"The exchanges have traditionally been monopolies and now are facing competition," said Larry Tabb, president of New York-based consulting company TABB Group. "Investors are beginning to get nervous," he added, pointing to the relative ease with which alternative trading systems, off-exchange electronic trading venues, have emerged.
Many of these systems are being built by the major Wall Street brokerages, the exchanges' biggest clients.
Executives from leading exchanges, including NYSE Euronext, the CME and NASDAQ, as well as several competing trading systems will discuss the fast-changing industry and the issues it faces at the Reuters Exchanges and Trading Summit from May 5 through 9 in New York and London.
Among those are the need to diversify across asset classes and the extent to which that need will continue driving their mergers and acquisitions.
Nasdaq's purchase in December of the Philadelphia Stock Exchange, set to close by summer, was designed to help it strengthen its position in the red-hot, high-margin options trading business.
In the first quarter of 2008, the acquisitions continued unabated as NYSE bought out longtime rival the American Stock Exchange in January. The move was aimed at helping NYSE expand into the trading of exchange traded funds (ETF), securities that mirror index mutual funds, and stock options.
CME's purchase of NYMEX NMX.N, meanwhile, will give it a foothold in energy derivatives trading.
Increasingly, investors are demanding the ability to trade securities and derivatives in one place. In fact, in the past 20 months, the Chicago Board Options Exchange and the International Securities Exchange have each begun operating stock exchanges to improve service to derivatives trading rather than take on the major exchanges.
All the while the threat to the major exchanges from alternative trading systems continues. BATS Trading, whose aggressive transaction pricing strategy has forced down trading costs, is set to become an exchange itself later this year. This has forced the major exchanges to take an "if you can't beat 'em, join 'em" approach as both NASDAQ and NYSE have beefed up their own alternative trading systems, including dark pools where large block trading takes place anonymously.
Even as the exchanges diversify across asset classes, the dark pools, which had mostly focused on equities trading, are starting to branch out into options trading. Goldman Sachs (GS.N) and 11 other firms, including Chicago hedge fund Citadel, are planning to form a low cost alternative futures market that would challenge CME Group's stranglehold.
A major determinant of who survives consolidation is determined by the strength of a company's technology, according to Edward Ditmire, an exchanges analyst with Fox Pitt-Kelton.
"The NYSE has consolidated with companies with better technology," Ditmire said, while NYMEX was gobbled up because it wasn't that strong technologically.
Traders expect execution in milliseconds, forcing all exchanges and ATS to invest heavily in technology. And technology compatibility is dictating which mergers work. NYMEX already uses CME's Globex platform, something that promises to make that union easier.
In contrast, the savings NYSE had expected to accrue from its merger with Euronext in 2007 have been slower in coming than anticipated, something for which the markets have punished NYSE-Euronext.
While consolidation will continue, it is expected to slow down. "We'll see a lull in consolidation while the exchanges chew what they've bitten off," said Ditmire.
(For summit blog: summitnotebook.reuters.com/)
(Reporting by Phil Wahba, editing by Phil Berlowitz)
