Why an Atlanta Upstart Is Buying NYSE (It's Not Stocks)
The iconic and once fiercely independent New York Stock Exchange is being sold not because of stocks but for the promise of its derivatives business.
The IntercontinentalExchange, viewed not long ago as an upstart commodities and derivatives exchange, agreed to buy NYSE Euronext for $8.2 billion, creating a new global exchange that trades futures, options and stocks.
The NYSE is the very symbol of Wall Street, and with its historic building at Broad and Wall is seen as the heart of the U.S. stock market and symbol of American capitalism. But new competitors, like BATS and others have been chiseling away at its business.
NYSE, along with its electronic trading arm, Archipelago, still holds the largest share of U.S. stock trading, with about 24 percent of all U.S. equities trading. Nasdaq, its oldest and biggest rival, has 19 percent.
While investors may think of the NYSE building as the physical center of U.S. stock trading, there is not expected to be any impact on individual investors and most of the trading takes place on electronic platforms. (Read More: NYSE-ICE Deal Reflects Diminishing Value of Stock Trading Business)
But it could impact institutions. It was not the stock trading business that ICE saw as the crown jewel, but the interest rate futures business the NYSE bought when it purchased Liffe, according to Richard Repetto, analyst with Sandler O'Neill.
"You have a more global competitor with interest rates," he said.
Interest rate futures are used by banks and asset manager to hedge against changes in interest rates, and ICE reportedly had hoped to buy Liffe in the past.
ICE-rival, Chicago-based CME, which also owns Nymex and its commodities floor in New York, is not likely to go on its own shopping spree because of the deal, he added.
But according to CNBC's Maria Bartiromo, the CME and NYSE had held informal discussions and those talks may have been motivation for ICE. It's unlikely CME will try to break up the ICE deal. ICE will clear for NYSE in London for the futures and dedicated business.
Tabb, Tabb Group CEO, does not think CME would go after NYSE, but it is set on building its own European business. But it is not interested in the equities business, as it said it would explore spinning off NYSE Euronext markets of Paris, Amsterdam, Brussels and Lisbon into a separately-listed company.
"It's absolutely a battle for Europe and it's a battle for the over-the-counter swaps business," said Tabb. "ICE pioneered this whole idea of swaps futures." (Read More: Top 10 Best and Worst Mergers of All Time)
U.S. banking regulation, under Dodd-Frank, is requiring more transparent trading and documentation of swaps, and the ICE business would be a beneficiary.
"What ICE did and subsequently CME has done is create a swaps future product that trades as a future and at some end date converts to a swap," he said. "They are exchange traded and they fall into central clearing." A swap is a bet on an exchange of values for instance in foreign exchange or in interest rates.
"That (deal) gets ICE into the rates business. The CME announced they are opening up in Europe so the CME has got a major initiative to build a European business. There will be increased competition," Tabb said. Besides energy and metals futures at the Nymex, the CME trades interest rate, currency, stock and agricultural futures in Chicago.
NYSE Euronext agreed to merge last year with Deutsche Bourse in a failed deal that was rejected by regulators. At the time, ICE and Nasdaq combined on counter proposals for NYSE Euronext, which it rejected. Ice was founded in 2000 and at its heart was an electronics commodity trading business, running the biggest energy futures market out of London. It also has smaller markets in the U.S. and Canada.
The NYSE, meanwhile is expected to maintain its building, which has seen its floor staff shrink over the years as electronic trading took hold.
"If there's any impact to retail people, it ultimately would be better technology which would ultimately result in better liquidity and better prices. I don't see much downside for retail investors," said Randy Frederick, director of trading and derivatives at Charles Schwab.
"There's lots of venues for equities to trade. The NYSE's percentage of total equity volume has dwindled year after year," said Frederick. "I think their profitability is impacted by their legacy cost structure. Back when they acquired the Pacific Exchange and Archipelago, they saw where the industry was going and moved in the right direction, and I think this is another one of those. (NYSE Euronext CEO) Duncan Niederauer knows someday the exchange business will become totally electronic."
But Tabb said there's value in the floor, home to the opening and closing bell.
"The floor business, believe it or not, is pretty critical to the NYSE business model, and actually the NYSE-listed securities business because it's kind of integral to the open and close," said Tabb. "The open and close are basically the best open and close process there is. It comes out with a very reliable price. Traditionally when you don't have a floor-based open and close, there's a lot of volatility with the opening price. I doubt very much the floor will go away, but that said, the whole middle of the day, you can use it as a bowling alley."
Tabb said a 2005 Securities and Exchange Commission rule that altered the structure of the equities market, splintered the market, making the business less appealing.
"That brought about change. Equities right now is not that interesting. It is a very competitive and fragmented world. Anytime you create too much market share, the broker dealers can just spin up another exchange," Tabb said.