Going publicBy Theresa Carey | Posted 04-22-2005
Big Merger Turns NYSE from Prey to Predator
Within days of the dust settling from the SEC's passage of the package of rules known as Regulation NMS, the New York Stock Exchange surprised the Street with its announced merger with Archipelago.
The merged entities will form a new company, to be called NYSE Group, which will be publicly traded.
NYSE's chair, John Thain, says, "This transaction, transforming the NYSE into a public for-profit entity, is an essential step to maintain our global competitiveness and leadership."
Bill Cline, Global Managing Partner for Accenture's Capital Markets Practice says, "To me it was a very clever and savvy deal by the NYSE. In one shot they got one of the best electronic platforms in the industry, a 25 percent share of Nasdaq trading, plus they get to demutualize and go public, and eliminate a competitor."
The timing of the deal, coming on the heels of the passage of Reg NMS and the extension of the trade-through rule to all U.S. equity markets, was not a coincidence.
Archipelago (Arca) was a vocal opponent of Reg NMS since the extension of trade-through to the Nasdaq was going to make it difficult for Arca to fulfill its public statement of taking share from the NSYE.
This merger also upends competitive perceptions among the exchanges.
The Nasdaq and other exchanges and ECNs (electronic communications networks), indicated through public comment that they considered the period of time that it would take the NYSE to implement a hybrid market as an opportunity to take share from them.
With the Arca takeover, the NYSE erodes most of the arguments against it, most of which involved speed and certainty of execution.
Arca positions the NYSE to not only retain the 25 percent share of Nasdaq trading, but also positions it to get into options and take a bigger share of ETF (exchanged-traded fund) transactions.
Trading in Nasdaq-listed stocks has been fragmented since a series of reforms were enacted in 1999.
A large portion of Nasdaq-listed stocks have been traded on regional exchanges and through ECNs in the last six years.
Nasdaq has made an effort to defrag that market by acquiring several ECNs, among them Brut and the newly announced takeover of Instinet.
With the merger of the NYSE and Arca, though, the liquidity in Nasdaq stocks is going to center on the two hubs provided by NYSE and Nasdaq.
Cline says, "I think the combination of this deal and Reg NMS, and trade-through specifically, puts real pressure on the regional exchanges to survive."
Next Page: The trading-floor tradition.
The Trading-Floor Tradition
How will this merger change the trading floor tradition at the NYSE?
Larry Tabb of The TABB Group says, "I don't believe that this merger will hasten, slow, or radically alter the NYSE's desire to move to a hybrid market structure, or to force the NYSE to jettison the floor and go fully electronic."
Tabb points out that the NYSE already has a matching engine for electronic orders, called Direct Plus, which is currently responsible for approximately 10 percent of the NYSE order flow.
Tabb states, "The reason they don't move to a more electronic platform is not that they can't; it's because they believe it to be in the benefit of the auction model."
Tabb believes that politics was the logjam in the NYSE's move to a more automated market.
NYSE's floor trading can add value for illiquid, thinly traded issues, and in big block trades where price improvement can be achieved on the floor.
Depending on how much of the flow goes off-floor and electronic, there might be less-than-necessary critical mass on the floor to operate efficiently, or to cost-justify maintaining and evolving the floor.
If the floor continues to play a useful role, it's a win for the NYSE since it's a differentiating factor for them that no competitor will duplicate.
The merger gives the NYSE front-end technology, with Archipelago's aggregation and direct market access capabilities.
It also gives the NYSE an entry into the options business, which is growing rapidly.
Tabb says, "This allows some very interesting cross-derivative and cash-product capabilities that could draw liquidity from the ISE, BOX, Amex, Philadelphia Exchange and the CBOE."
Tabb believes that derivatives may very well be the next battleground, and the possibility of developing a combined cash and derivative business provides the NYSE with interesting product, arbitrage and profit possibilities.
Next Page: Going public.
The announcement that the combined firm will have its own IPO is a continuation of the trend of exchanges going public.
The U.S. exchanges have lagged behind their European counterparts as far as being publicly traded, and as a result have lagged as far as having aggressive growth agendas.
The European exchanges especially are diversifying and introducing new products to maintain profitability.
Cline notes, "I think we're entering a period of real dynamic changes and growth that will be exciting to watch. I predict that the U.S. exchanges will be more significant global players. I believe that growth and the raising of stock prices will come through innovation and expansion."
IT sales provide an area where European exchanges have been able to leverage their IT investments.
The Deutsche Boerse, for example, recently licensed its XETRA trading system to the Shanghai Stock Exchange.
Cline's group at Accenture is leading the effort to enhance and customize XETRA for the Shanghai exchange.
"This deal is good for Shanghai because they get a mature platform," notes Cline.
"And it's good for the Deutsche Boerse because they get income for their IT investment."
Cline believes that the NYSE will be poised to provide technology to exchanges around the world, with the addition of Archipelago's top-notch IT department.
Scale is still important in this business, and IT investments at exchanges are quite heavy.
Selling IT is a smart strategic play that leverages that investment over a larger base and also builds relationships between exchanges.
As the exchange market becomes increasingly global and national boundaries get less important, we may see those seed relationships that start with IT go much further.
As U.S. exchanges become more growth- and profit-conscious, we will likely see them participate more fully in this game.
Theresa Carey is finance editor for Ziff Davis Internet's Enterprise Edit group. She's been writing about financial technology issues since 1990 for a wide variety of publications.
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