Now that the NYSE Group/Euronext deal has closed and the dust has settled on the consolidation spree among equities exchanges, the action has turned to the world of futures and options, which currently is enjoying burgeoning growth in both volume and transparency, spurred by global trading arrangements and the increasing electronification of the markets.
Longtime crosstown rivals the Chicago Mercantile Exchange (CME) and the Chicago Board of Trade (CBOT) agreed to merge in October 2006, a deal that would create the world's largest derivatives exchange, promising $125 million in annual expense savings for the exchanges and $70 million in savings annually for customers. Though the deal was expected to close by mid-2007, it still is under regulatory review, and on March 15 the IntercontinentalExchange (ICE) threw its own proposal to purchase CBOT in the ring.
The ICE's all-stock bid was valued at a 10.5 percent premium (at the time, about $750 million) above CME's offer. As a result of ICE's counter proposal, a CME shareholders meeting has been pushed back — now that ICE has entered the game, CBOT and CME plan to vote on their proposed merger in July.
Just one day before the ICE's proposal was made public, CME and CBOT announced that their plan to consolidate trading-floor and electronic-trading operations — in the CBOT building and on CME's Globex system, respectively — would be accelerated. The time line for the completion of consolidation on the Globex system was moved from "one year following merger close" to the first quarter of 2008; the time line for floor consolidation was moved from "12 to 18 months following merger close" to the second quarter of 2008, the exchanges say.
According to a CME spokesperson, "Our initial time lines were based on early high-level planning. Now that we've spent more time in detailed planning, we are confident that we can reduce the consolidation time frames."
The timing of the announcement was probably not coincidental, notes Dushyant Shahrawat, an analyst with TowerGroup. "They are putting a word out to the shareholders that this is under way and these guys [the ICE] are too late," Shahrawat says. "It's strategic."
Some of the advertised savings are expected to come from the fact that the CME owns the Globex platform, while the e-CBOT trading platform is a licensed version of the Liffe Connect system, which is distributed by Atos-Euronext, the technology arm of NYSE Euronext, the CME spokesperson says. Other advantages touted by the CME include the existing agreement by which trades on CBOT are cleared through CME's clearing system, and the fact that the two exchanges have all but eight members in common.
A Better Deal?
However, given the short-term gain associated with ICE's all-stock offer, CBOT shareholders may not be persuaded by these arguments. "You are giving shareholders a lot of credit if you believe that a press release is going to make them turn down a 25 percent better offer," asserts Adam Sussman, analyst at TABB Group. "If you hold a stock in CME and CBOT, and they say, 'But we are so far along,' you are not going to care."
On the technology front, the all-electronic ICE would migrate the CBOT off the e-CBOT system onto ICE's own trading and clearing systems, according to an ICE spokesperson. At present, the ICE's proposal is to retain the CBOT floor in its existing state. The ICE was not able to offer a time line because it was in the process of information discovery when this article went to press, the spokesperson says.
ICE's system is newer than Globex and has been used to launch innovative new products in energy trading, Sussman notes. And while ICE's systems were predicated on a fully electronic business model, whereas Globex was created with the trading floor in mind, ICE has shown the potential to absorb open-outcry operations in the past, including the floor operations of the International Petroleum Exchange (2005) and NYBOT (2006).
In the standoff, traders are playing their cards close to their vests. Traders at Rosenthal Collins, R.J. O'Brien and Calyon Financial, all major players in the futures market, declined to comment for this article.
Still, it's a fair guess that traders have become accustomed to the CME proposal, which has been on the table for six months. "Most traders agree that the CME is the better strategic bid for CBOT," Shahrawat asserts.
However, traders who cut their teeth in the electronic markets may have a different view — that innovation in product strategy and technology is the path to better trading opportunities. "There is a lot of stock to be had in ICE and CBOT getting together," says Andrew Wilkinson, senior market analyst at Interactive Brokers/Timber Hill and a former trader on the LIFFE system. "CME and CBOT tying up all of those contracts together is monopolistic. ... One might think the board would want to go with a new kid on the block — there is more potential to reach a new audience."
Nasdaq Eyes Philly Stake
Not to be overshadowed by the hype in the futures market, according to media reports, in mid-April Nasdaq made an offer to purchase the Philadelphia Stock Exchange (PHLX), one of the principal equity options exchanges in the U.S. The move is seen as a likely retort to the NYSE Group's acquisition of Archipelago, which itself had previously absorbed the Pacific Exchange, a regional options market. While Nasdaq declined to comment, a PHLX spokesperson says, "We talk to many people; we have not made a deal and are still exploring an IPO."
In this age when going electronic and going public are the new paradigm for market centers, the pressures on the PHLX are the same as those that drove CME and CBOT first to go public, then to merge. Size and product innovation, combined with consolidated platforms, are the survival tools of any marketplace.
The PHLX has about a 15 percent market share in the options market, behind the Chicago Board Options Exchange and the all-electronic International Securities Exchange (ISE). Nasdaq has stated its intention to enter the options market and to gain 20 percent market share, according to Aite Group analyst Brad Bailey.
If the PHLX does not go public it will not be able to make acquisitions as easily and move as quickly in terms of innovation, contends TABB's Sussman. However, transitioning to an all-electronic exchange likely would happen more quickly under Nasdaq, he notes.
As with any attempt to gain market advantage quickly, it is almost always easier to buy than to build. But in this case, Nasdaq would be buying clientele, not technology, Sussman observes. "Nasdaq announced plans for an options business, and it is not happening yet," says Sussman, who helped integrate Ameritrade with Datek Online before joining TABB Group. "The big stumbling block was not technology; it was getting people signed up. By buying Philly, they buy the client base and all the relationships Philly already had."
Monopoly or Fragmentation?
As far as traders are concerned, there is an inherent assumption that competition is always optimal and that a monopoly is a negative. But if exchanges are able to realize cost savings by acquiring each other and merging systems, it's possible that trading costs also will go down.
"Most institutional traders see choice as something of a burden, up to the point where they see their costs go up," says Sussman. "Fragmentation is the downside of competition — a burden of that freedom."
If exchanges keep up their rapid pace of consolidation in the burgeoning market, fragmentation may fall off the list of common trader complaints, to be replaced by collusion and monopolistic pricing, TowerGroup's Shahrawat suggests. "Exchanges can drop prices to the point they lose money on a service and can then drive out competition," he says. "Once they have the market to themselves, they can jack up the price."
At Press Time:
The International Securities Exchange (ISE) is in advanced discussions to be acquired by Deutsche Borse and combine its business with Eurex. "This move will offer the Deutsche Borse an excellent foothold into the very rapidly expanding U.S. options market and allow DB to bring the ISE platform to Europe," says Aite Group senior analyst Brad Bailey. "Now that ISE has been put in play, in public, it would come as no surprise if other exchanges expressed interest in ISE, including NYSE Euronext."