The biggest day ever for mergers of securities exchanges triggered rallies in shares of operators from New York to Chicago and Sao Paulo as derivatives overtake stock trading as the drivers of growth.
Nasdaq OMX Group Inc., IntercontinentalExchange Inc., CBOE Holdings Inc. and BM&FBovespa SA — all of which run derivatives platforms for futures or options — rallied as much as 6.7 percent yesterday. The gains followed Deutsche Boerse AG’s announcement that it’s in talks to buy NYSE, valued at almost $10 billion, and LSE’s $3.1 billion bid for TMX Group Inc.
While the combinations will create markets that control trading in companies worth more than $20 trillion, or about 36 percent of the world’s stock-market value, what may prove more lucrative is ownership of growing venues for trading options, futures and derivatives whose profit margins are 57 percent more than equities at NYSE Euronext.
“We haven’t seen the endgame,” said James Angel, a professor at Georgetown University in Washington. “The margins in futures are juicier than in equities because of the clearing,” he said. “The profitability of equities is squeezed because it’s kind of a dogfight with competitors.”
The merger of NYSE Euronext, owner of the New York Stock Exchange, NYSE Liffe and NYSE Arca Options, and Deutsche Boerse, which runs Europe’s largest securities exchange, would create a company that controls 11 derivatives markets, according to the Futures Industry Association. Deutsche Boerse of Frankfurt also has a stake in Eurex AG, which owns part of the International Securities Exchange. NYSE shares surged 14 percent yesterday, the most since December 2008, and Deutsche Boerse rallied 3.1 percent at 10:03 a.m. in Frankfurt today.
The new organization’s market share of futures trading would top the proportion at CME Group Inc., the product of the $9.6 billion merger of the Chicago Mercantile Exchange and the Chicago Board of Trade that rose 0.5 percent yesterday. The merger would combine three of the nine U.S. options exchanges to surpass the Chicago Board Options Exchange as the nation’s largest market for the derivatives.
Nasdaq OMX surged 6.7 percent yesterday, the most since May 2009 for the New York-based firm. IntercontinentalExchange, the world’s largest credit swap clearinghouse, climbed 4.2 percent. The company, also known as ICE, is based in Atlanta. CBOE rallied 4.3 percent, its sixth straight advance. Sao Paulo-based BM&FBovespa, which owns Latin America’s biggest securities exchange, rose 3.6 percent.
Hong Kong, Singapore
In Asia, Hong Kong Exchanges & Clearing Ltd. said it’s open to mergers, and its shares fell 1.7 percent yesterday and 4.9 percent today for the biggest two-day drop since May 2009. ASX Ltd. rose 4.7 percent today, the most since Singapore Exchange Ltd. agreed to buy the Sydney-based operator of Australia’s exchanges for A$8.35 billion ($8.42 billion) in October.
Lee Underwood, a spokesman for ICE, as well as CBOE’s Gail Osten, Nasdaq’s Silvia Davi, BM&FBovespa’s Alcides Ferreira and CME Group’s Michael Shore declined to comment on speculation that there will be more industry mergers.
Profit growth for exchanges is being driven by derivatives, after increased regulation reduced operating margins for stocks at NYSE Euronext to 35 percent, compared with 55 percent for the contracts whose value is linked to an underlying asset.
ICE is earning higher pretax profit margins by guaranteeing credit-default swaps, insurance policies linked to the creditworthiness of corporations and governments, with its clearinghouse than banks make by selling fixed-income securities and equities to institutional investors, the company reported yesterday. Clearing is when a processor guarantees payment for transactions and ensures delivery of securities.
While stocks can be traded across platforms, futures are cleared by only that exchange’s clearinghouse. That means once a venue lists a contract, it remains the only one that offers it. Deutsche Boerse owns Clearstream, Europe’s second-biggest securities settlement company, as well as Eurex Clearing AG, which clears equities, derivatives, repo and fixed income. Clearstream handled a record 10.6 million settlement transactions in December, up 23 percent from a year before.
Derivatives have been one of the fastest-growing revenue units for exchanges, as stock trading slumped amid more competition from alternative trading venues started in the past decade. NYSE Euronext’s equity-trading sales fell 10 percent in 2010, while the options and futures unit gained 14 percent. At Nasdaq, derivatives revenue grew 30 percent in the fourth quarter, more than any other area.
“Growth in derivatives is tremendous,” said Jon Najarian, the co-founder of OptionMonster.com, who owns shares of NYSE, CBOE and CME.
The Chicago Board Options Exchange had the biggest share of U.S. options in 2010, according to Options Clearing Corp. data. The options exchange may entice bidders because of its exclusive license to trade contracts linked to the VIX, as the CBOE Volatility Index is known, and to the Standard & Poor’s 500 Index, Najarian said.
Nasdaq OMX, Hong Kong Exchanges & Clearing or BM&FBovespa may consider buying CBOE to expand their market share, according to Thomas Caldwell, chief executive officer of Caldwell Securities Ltd. in Toronto, which, with its affiliates, oversees about C$1 billion ($1 billion), including Deutsche Boerse, NYSE, CBOE, LSE and TMX shares.
CME, the owner of the world’s largest futures market, controls 98 percent of U.S. futures trading, including contracts on the S&P 500, and has been growing per-share profit every quarter since the three months ended March 31, according to data compiled by Bloomberg.
In 2007, the Chicago Merc merged with the Chicago Board of Trade, creating CME Group, and offered trading in short-term and long-term interest-rate futures. The tie up of Deutsche Boerse and NYSE Euronext would do the same thing for European interest- rate futures, said Rich Repetto, an analyst at Sandler O’Neill & Partners LP in New York.
“One question is, what will the CME do?” said Angel, the finance professor at Georgetown. The company may merge “to protect their home turf,” he said.
For Nasdaq, an acquisition is probably necessary to compete with Deutsche Boerse and NYSE, said Sang Lee, co-founder and managing partner at research firm Aite Group LLC in Boston. In 2008, the New York-based exchange operator bought Stockholm- based OMX AB, Europe’s fifth-largest stock exchange, after two failed attempts to acquire LSE. In April, the exchange announced plans to shutter its euro pan-European alternative trading system, which it had introduced in 2008.
“I do see synergies if they merge with someone, but it all comes down to what price,” said Jeff Middleswart, based in Dallas, who said he owns about 30,000 Nasdaq and 18,000 NYSE shares.
Both deals this week should help the companies reduce expenses, with the Deutsche Boerse deal saving 300 million euros ($411 million), according to yesterday’s release. Deutsche Boerse plans to standardize on NYSE Euronext’s cash equities trading system, a person familiar with the matter said yesterday.
“The exchange business is a scale business,” said Justin Schack, managing director in charge of market structure analysis at Rosenblatt Securities Inc. “You have technology infrastructure to process transactions, so the more transactions you can process the better. And by acquiring another exchange group and running them all on a single technology platform, you can generate significant cost savings.”
BM&FBovespa is ideal for an acquirer because of its derivatives trading, Lee and Najarian said. Trading of interest rate futures helped lift the average daily volume at the company’s BM&F segment by 71 percent in the third quarter from a year earlier, according to a BM&FBovespa statement. Volume at Bovespa, where stocks trade, rose 13 percent in the same period. The company increased net income by 50 percent in 2010, according to the average analyst estimate compiled by Bloomberg.
“Brazil is such an active marketplace and they are already an active exporter because they have such big grain exposure and so forth,” Najarian said. “They’ve got a hold and they’re doing really well.”
The company also partners with other exchanges, including holding a 5 percent stake in CME and agreements with Nasdaq OMX and Chile’s Bolsa de Comercio de Santiago. That should set the company up for an easier merger with other exchanges, Lee said.
“Exchanges are struggling to a certain degree to try to figure out how to grow,” Lee said. “If they want to continue to try to evolve, consolidation is the way to go.” The announcement of the deal between London-based LSE and TMX of Toronto may have “triggered a second wave.”
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