NYSE Death as Dominant Exchange Presaged German Deal
The New York Stock Exchange, the symbol of American capitalism for more than a century, may merge with a German rival after losing ground to smaller competitors.
NYSE Euronext, the owner of the NYSE, is negotiating to be acquired by Deutsche Boerse AG with equity valued at $10 billion after its market share dwindled to 23 percent from 80 percent in the past six years. The new company will be the biggest exchange owner, handling equities worth $15 trillion and 40 percent of the U.S. options market.
The 219-year-old exchange led by Chief Executive Officer Duncan Niederauer, home to General Electric Co. and Ford Motor Co., was diminished as regulators opened U.S. markets to more competition after investors demanded lower trading costs. The sale to 18-year-old Deutsche Boerse in Frankfurt shows the increasing importance of machines over humans in trading stocks and the rising influence of derivatives, where profit margins are as high as 55 percent.
“Sadly, the NYSE became a victim of its own success -- too large and dominant to move quickly to adapt,” said Peter Kenny, a managing director in institutional sales at Knight Capital Group Inc. in Jersey City, New Jersey, who became a member in 1987. “It is not all bad, but it is very sad to an old timer like myself.”
The biggest day ever for exchange mergers triggered rallies in shares of operators from New York to Chicago and Sao Paulo. Nasdaq OMX Group Inc., IntercontinentalExchange Inc., CBOE Holdings Inc. and BM&FBovespa SA -- all of which run derivative venues for futures or options -- rallied as much as 6.7 percent yesterday.
Deutsche Boerse rose 4.6 percent to 61.10 euros today in Frankfurt. NYSE Euronext shares slipped 1.2 percent to $37.64, paring yesterday’s 14 percent rally. Their total market value of $26 billion exceeds Hong Kong Exchanges & Clearing Ltd.’s, currently the world’s largest by market capitalization at $23.2 billion.
“We are still waiting for more details and are flying a bit blind right now,” said Timothy Ghriskey, chief investment officer at Solaris Asset Management in Bedford Hills, New York, which manages $2 billion. “But the market likes the combination of cross-board stock exchanges.”
With as many as 50 venues trading equities in the U.S. compared with fewer than 20 a decade ago, competition has driven down the amount exchanges can charge for executing trades. Brokers who owned the NYSE 10 years ago earned 6.25 cents or more when buying and selling 100 shares. Now, the spread is a penny for the most heavily traded stocks.
NYSE Euronext said derivatives revenue climbed 14 percent in 2010, while overall sales declined for two straight years. Derivatives are contracts whose values are determined by underlying assets.
Deutsche Boerse, which may buy NYSE Euronext for about $10 billion in stock, would own about 60 percent of the new company. Niederauer, 51, would be chief executive officer of the new organization. Reto Francioni, the 55-year-old CEO of Deutsche Boerse, would be chairman.
“You’ll have the two strongest stock exchanges together, and it’s going to give us access to Europe, and them access to the United States in a way that some of our other competitors, like London, will not have,” New York Mayor Michael Bloomberg said at a news conference today. “You’ll add jobs because the stronger the New York Stock Exchange is in our global world, the better off we are.” The mayor is founder and majority owner of Bloomberg News parent Bloomberg LP.
The New York Stock Exchange, formed in 1792 under a sycamore tree on Wall Street, became the center of American capitalism through its grip on stock listings and trading. During the crash of 1987, Chairman John J. Phelan won praise for securing pledges from executives of some of the exchange’s biggest companies to buy back their own stock.
The Big Board’s reputation faded in the last decade when scandals highlighted the potential for collusion on the NYSE floor and faster technology reduced the need for middlemen.
In September 2003, Chairman Richard Grasso ended a 36-year career at the exchange as regulators and directors said a $140 million pay package called his leadership into question. Two years later, the U.S. charged 15 NYSE specialists with fraud, saying they manipulated orders for four years to pocket $19 million at clients’ expense. The NYSE was censured for self- regulatory failures and agreed to submit to outside monitoring for the first time.
Grasso’s successor, John Thain, orchestrated the 2006 reverse merger that gave the NYSE control of Chicago-based Archipelago Holdings Inc. and turned the member-owned exchange into a public company. By then, regulatory directives aimed at lowering transaction costs were in the process of cutting the NYSE’s market share.
The 2001 switch to decimal share pricing, from sixteenths of a dollar, allowed any firm willing to sell for a penny less than the best available price to step in and make the trade. That reduced margins for specialists on the floor of the exchange. Automated-trading firms such as Getco LLC in Chicago used high-speed computers on electronic venues such as Bats Global Markets in Kansas City, Missouri, and Jersey City, New Jersey-based Direct Edge Holdings LLC to overcome lower profits by sending thousands of orders to trade every second.
Ways to Grow
At the same time, exchanges around the world were combining, with at least $95.8 billion of mergers completed since January 2000. NYSE combined with Euronext NV in 2007. TMX bought Montreal Exchange Inc. in 2008, a year after London Stock Exchange Group acquired Borsa Italiana SpA. ICE purchased the New York Board of Trade in 2007 and Bolsa de Mercadorias e Futuros bought Bovespa Holding SA in 2008.
Futures exchanges around the world traded 8.2 billion contracts in 2009, almost three times the turnover in 2003, according to data from the Futures Industry Association.
With rivals taking business, one of the quickest ways for NYSE Euronext to grow is through mergers and acquisitions, said Michael Pagano, a professor of finance who studies exchanges and market structure at the Villanova School of Business in Villanova, Pennsylvania.
“It costs a fixed amount of money to build a computer system for trading, but once you generate revenue that covers those fixed costs the marginal cost of covering just one additional trade beyond that is basically just electricity,” Pagano said.
That’s led to a reduction in costs. Total salaries and benefits at NYSE fell by 5.6 percent to $613 million last year, the biggest drop since the data on the publicly traded company began in 2005. Deutsche Boerse, which is scheduled to release results next week, cut staff expenses by 3.7 percent in 2009 and 26 percent in 2008, according to data compiled by Bloomberg.
NYSE Euronext owns exchanges in Amsterdam, Lisbon, Paris and Brussels, as well as London-based Liffe, Europe’s second- largest derivatives market. The company also runs three U.S. stock exchanges: NYSE Arca, NYSE Amex and the New York Stock Exchange, two options platforms and the NYSE Liffe U.S. futures exchange, which trades contracts linked to interest rates.
Deutsche Boerse operates the Frankfurt stock exchange and Clearstream, Europe’s second-biggest securities-settlement firm. The company also has Eurex Clearing AG and a 50 percent holding in Eurex, the region’s largest futures market. Eurex bought a stake in International Securities Exchange, an options market that competes with CBOE, in 2007.
“In Exchange 101, it’s about operating leverage,” said Jamie Selway, managing director at Investment Technology Group Inc. in New York and an expert in how markets are organized. He said NYSE Euronext and Deutsche Boerse can combine and eliminate more costs in personnel and technology. “You spend a fixed amount of cost to operate platforms. Anything additional you can trade on them is incremental revenue.”
NYSE and Deutsche Boerse may move to a single execution system, coordinating trading services and eliminating jobs in areas such as sales, marketing and computer support. The combined exchange will use NYSE Euronext’s trading system for cash equities, said a person familiar with the matter who declined to be identified because the talks are private.
The deal would give the combined company about 40 percent of U.S. options volume by adding NYSE Euronext’s two markets with the ISE, currently the third-largest venue. CBOE was the biggest options exchange operator last month with 30 percent of contracts handled on its venues.
Combined, the companies will be the world’s largest futures market by volume, according to data from the Futures Industry Association, a trade group representing Wall Street banks active in derivatives. The merged firm would control 11 derivatives markets, including Liffe U.K., NYSE Arca Options, NYSE Liffe U.S., Eurex and the International Securities Exchange. The combined venues would have posted volume of 4.8 billion contracts in 2010, according to FIA.
That compares to 3.1 billion trades last year at CME Group Inc., the world’s largest futures exchange, FIA said.
NYSE Euronext would also handle clearing, the guaranteeing of payments for transactions and delivery of securities, for equities and futures in Europe through businesses run by Deutsche Boerse. Combining products in the same clearinghouse limits the ability of other markets to compete.
“Expanding a good, modern system that already exists like NYSE costs very little,” said Alfred Berkeley, chairman of Pipeline Trading Systems LLC in New York and president of Nasdaq Stock Market from 1996 to 2000. “They can eliminate all that redundancy in Deutsche Boerse and do a lot more business and a lot more trades than they’re doing now.”