Do you remember going to birthday parties as a child and playing musical chairs? The game started off with a lot of excitement, slowed down in the middle as the competitive kids dominated the action, then grew frantic when only two or three chairs remained. This is the same pattern followed by financial-market exchange consolidation.
When I worked at the New York Stock Exchange in 2004, we had two strategic mandates. First, understand the business and determine the competitive landscape. Second, use game theory as a basis for good strategic choices.
The game theory, the potential combinations written on a white board, is what is playing out now. The objective, at the time, was to ensure that the NYSE maintained control and was the buyer, not the seller. We wanted to control our own destiny by making sure we were a few steps ahead of the competition.
Although the game is still going on, there aren’t many chairs left and, as last week’s announcement suggests, NYSE Euronext isn’t among the ones with a chair to sit on.
The NYSE turned out to be much smaller, less profitable and more vulnerable to competitors than its brand suggested. While the NYSE controlled more than 90 percent of the U.S. cash-equities market, its market share -- when accounting for futures, options and other assets traded on global exchanges -- was less than 5 percent.
As market structure changed, and became more electronic, so did the economics of the business. Transaction revenue was dwindling, and listing fees were under scrutiny. New sources of income needed to be found. We looked to higher growth, wider-margin businesses in Europe, clearing and derivatives as the Holy Grail. New competitors, such as IntercontinentalExchange Inc., or ICE, which agreed last week to buy the NYSE Euronext for $8.2 billion, entered the business with few barriers and little baggage, good or bad. Many of these newcomers had a public currency and multibillion-dollar market values.
Meanwhile, the NYSE struggled to convince its members and regulators that the game was changing and that the exchange needed to change, as well. The next step was to determine what action to take. Imagine the first moves in a game of chess; good players try to think a few moves ahead. If the goal was to be more efficient, one deal alone wasn’t going to do the trick.
Key assumptions on the white board started to take form: Smaller exchanges, such as the Irish Stock Exchange, Archipelago Exchange and Chicago Board of Trade, would be gobbled up. Deutsche Boerse AG, with its complicated ownership structure, might wait too long or move too slowly. At the end of every anticipated scenario, Nasdaq was acquired by a larger exchange.
The biggest assumption was that the Chicago Mercantile Exchange (now CME Group Inc.), with a market value larger than the NYSE, would be big enough to be a buyer under almost any circumstances. It didn’t want to enter the slower-growing and less regulator-friendly cash-equities market, meaning the NYSE probably wouldn’t be one of its targets.
In an odd twist, the combination of the NYSE and ICE may force the CME and Nasdaq OMX Group Inc. together in order to maintain balance in the U.S. markets.
Finally, what I find so remarkable is what wasn’t foreseen back then. I don’t recall anyone anticipating that ICE would be one of last ones still playing the game.
For me, and perhaps like so many who grew up on Wall Street, it is a bittersweet day. It isn’t surprising that the economics of the cash-equities business don’t dominate the competitive landscape. We aren’t surprised now that ICE, its management and board have done so well. We probably aren’t surprised that previous deals that would have maintained the NYSE stature and independence fell through. However, we can feel sentimental that a once-great institution is no longer on top or in control.
(Amy Butte is the former chief financial officer of the New York Stock Exchange. The opinions expressed are her own.)
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