Majestic Research

Financial Times

Thain Considers a European Push

By John Authers
Published: March 07, 2006

On which front will the New York Stock Exchange fight next?
From tomorrow morning, it is likely to be armed with a strong share price, giving it a great acquisition currency. There is speculation - stoked by the comments of its chief executive, the former Goldman Sachs president John Thain - that the NYSE will spend it on an acquisition spree, looking to pick up one of the big European stock exchanges or a US options exchange. But could it instead be sucked into a domestic price war with its New York rival, the Nasdaq stock exchange?

Until now, the NYSE’s main concern has been to serve its members. Now it will need to maximise profits. Doug Atkin, a former chief executive of the Instinet trading network bought by Nasdaq last year, suggests this could lead the two New York exchanges into a classic economic “game” of co-operation or competition.

Robert Greifeld, Nasdaq’s chief executive, made clear his intention to aim directly at the NYSE’s market share when he closed the deal to buy Instinet. “First and foremost, we have a clear and present opportunity to gain a tremendous trading share in the cash equity market for those stocks listed on the NYSE,” he said.

According to Mr Atkin: “We are really concerned that Nasdaq is taking such an aggressive stance against the NYSE and going after that business. Our view is that if Nasdaq just sticks to its knitting and doesn’t wake up the 8,000-pound gorilla, then Mr Thain is more than willing to give Nasdaq its market and settle into a duopoly - in return for Nasdaq letting the NYSE get on with raising prices.”

He pointed to Europe, where there has been extensive consolidation among exchanges and where trading fees are five times those charged by the NYSE and Nasdaq.

On Mr Atkin’s analysis, barriers to entry are high - the classic economic pre-condition for a monopoly or duopoly to survive. Exchanges, particularly the NYSE, can also draw on cross-subsidies from lucrative businesses such as listing fees in which they enjoy a quasi-monopoly.

“Once you have the liquidity, it’s really difficult to start a successful competitor,” he said. “It’s almost like [internet auctioneer] Ebay - even if a competitor said you could auction your product with them for nothing, you are still going to lose on the price you get for your merchandise if the liquidity isn’t there.”

Mr Thain disputes this analysis: “On the trading costs side I think the markets will remain very competitive,” he says. “It’s not very hard to create new exchanges and new marketplaces. It’s hard to create the liquidity pool but it’s not very hard to create the marketplace. That means that you don’t have as much pricing power as you would think.”

Citigroup, the world’s largest financial services company, has said it will launch its own electronic trading network, in an implicit hedge against the risk that the two big exchanges would raise prices.

“Our industry is so competitive and you can see these hedges that are being taken by the broker-dealers and hedge funds,” says Bill Cline, head of the exchanges practice at Accenture. “That makes large fee increases from the exchanges unlikely.”

He thinks Nasdaq is unlikely to seek to compete on price and will instead continue to emphasise what it regards as its superior electronic trading system. “This is where the question of the NYSE’s trading floor will ultimately come in, because it’s more expensive and that cost ultimately has to be reflected in the total cost of trading,” he says.

Mr Cline draws a comparison with the Chicago Board of Trade, which fought off price competition from Eurex by lowering its own fees - in part by offering electronic trading.

This could be a problem. One industry veteran said he “would not want to be in John Thain’s shoes”, as the multiples on exchange stocks show that the market is expecting the industry to continue to grow very fast. Chicago Mercantile Exchange has seen its share price multiply tenfold since going public and trades at much the same earnings multiple as Google.

But to many insiders, the business looks mature and cyclical. “The kind of multiple the NYSE and Nasdaq will be selling at contemplates growth in excess of what’s possible,” says one, “so they’ll be left to try to grab from each other”.

Their only other way to build profits is via acquisition - either to diversify products, or to diversify geographically.

Exchanges make their money from trading volume. Revenue generated from pumping new products through the trading infrastructure NYSE acquired in the Archipelago deal would pass almost directly to the exchange’s bottom line.

This would point to equity options. According to the New York-based International Securities Exchange, trading volumes in equity options have tripled since 2000, making them an exceptionally high-growth product. Moreover, they are easily adapted to trading over the NYSE’s existing stock-trading platforms.

Finally, there is the option of plunging into the consolidating market for European exchanges. Mr Thain does not hide his interest in this. “There’s an opportunity to combine liquidity pools and offer investors the ability to trade across both of them,” he told the FT. “You can combine platforms and you can also reduce your costs. Euronext has consolidated Amsterdam, Brussels and Paris and Lisbon and put them all on one platform, and consolidated their liquidity pools.”

The safest bet, wherever the battle takes the NYSE, is that the huge change that starts tomorrow will not be its last. The game of consolidation must play out for a while longer yet.