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Harley Lippman, CEO, Genesis10
Harley Lippman, CEO, Genesis10
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The Feeling is Demutual

Genesis 10 CEO Harley Lippman explains how technology is dictating demutualization to the world's financial exchanges.

Another advantage of demutualization is that it allows exchanges to enter into new strategic alliances, a trend that we've seen more and more of, particularly since the merger of AMEX and NASDAQ. Testifying before the Senate Banking, Housing, and Urban Affairs Committee on May 8th of this year, CBOT Chairman David Brennan said that ""national borders do not limit any market's customer base, and successful exchanges are those that take steps to cross borders and create partnerships that will bring more choices and increased efficiency to customers."" He then went on to talk about the alliance between the CBOT and Eurex, the German-Swiss electronic derivatives exchange.

Alliances between competitors are certainly not new, such as when the Chicago Mercantile Exchange and the New York Mercantile Exchange developed a clearing system back in 1998, which was also adopted by the three French exchanges SBF-Paris Bourse, MATIF, and Monep. The CME later announced a partnership with the London International Financial Futures & Options Exchange to trade each other's short-term interest rate contracts electronically.

But the frenzy to align and conquer is certainly heating up. Recently there's been a move by both the NYSE and the NASD to form some kind of agreement with the now demutualized Toronto Stock Exchange in an effort to create a new American exchange covering the U.S., Canada, Mexico, and Brazil. Clearly, all of the major American exchanges are looking to demutualize so that they can, among other things, form alliances quickly and keep up with the hectic pace of change in how financial instruments are being traded worldwide.

In many ways, demutualizing financial exchanges appears to offer nothing but up-side: the ability to respond and adapt to a fast-changing marketplace characteristic of for-profit corporate organizations; the ability to tap equity sources, allowing exchanges to compete on the always-expensive technology level; the ability to leverage the value of the exchange itself as a brand and as a business entity in ways other than trading; the ability to form strategic alliances as electronic trading becomes a 24-hour-a-day worldwide activity; and finally the ability to compete with new forms of electronic trading run by for-profit businesses free from regulatory restrictions.

But if demutualization is great for the exchanges themselves, the question arises: will it be equally beneficial to the exchanges' direct customers and to investors both big and small? Must we not ask as the apocryphal young broker did when shown the yachts of investment bankers moored on the river at Wall Street: ""But where are the customers' yachts?""

Well, if no one else is asking, SEC Chairman Arthur Levitt certainly is. In his testimony before the Senate Banking Committee's Subcommittee on Securities back in October, Chairman Levitt noted that ""the forces of competition, technology, and globalization have converged to spur innovation and to transform the way business is done in the securities industry. Although these forces have been enormously beneficial in many ways, they raise pressing challenges for the Commission and our markets.""

The specific issue, of course, is that if U.S. exchanges (which as not-for-profit mutual organizations have been considered and treated as self-regulating organizations) suddenly become for-profit corporations, can they still be trusted to regulate themselves? Richard Grasso had earlier argued to the Banking Committee that they could and should be allowed to regulate themselves, but Chairman Levitt seems unconvinced, stating that ""at a minimum, there must be strict separation of the self-regulatory role from the marketplace it regulates."" In certain ways, the 1996 reorganization of the NASD into separate companies -- NASD Regulation, Inc (NASDR, a self regulator) and The Nasdaq Stock Market, Inc. (NASDQ) shows the same kind of anticipative quality that has been part of the NASD since it started trading without a floor back in 1939.

Clearly, some form of self regulation is on every exchange's mind as they ponder self re-invention. The day after it demutualized, the Toronto Stock Exchange announced the creation of an individual business unit that would separate market regulation from its for-profit business operations. Barbara Stymiest, TSE's president, called the separate division a way ""to reassure our customers that regulatory services will continue to be provided without conflict of interest and in a fair and unbiased manner."" But although its costs and revenues will be separate from the for-profit part of TSE Inc., it is still a division of the corporation, not a separate corporate entity. And it remains to be seen if this type of self regulation will pass muster with the SEC.

If exchanges are going to compete with for-profit corporations, they will have to operate in the same efficient manner. Clearly the old way of doing things is giving way to the unstoppable forces of technology and its twin sister efficiency. But it is also clear that no way of selling financial instruments will last if customers can't or don't have at least the same level of trust in the organizations that are handling their transactions as they do in the current exchanges.

One of the more interesting concepts in the blockbuster Jurassic Park is the idea that nature finds a way, no matter what challenges come up. And this is undoubtedly the case in the buying and selling of financial instruments. Member-owned exchanges and their government regulators may or may not agree, but its clear that on many levels, the feeling seems to be overwhelmingly demutual.

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