ICE And NYX Sitting in A Tree

Posted by Jeff Carter
on December 20th, 2012

The $ICE exchange is viewed by many old time $CME members as an upstart. If one were categorizing exchanges and their business models, ICE would be the startup. CME liked to think of itself as the start up since it’s one of the younger exchanges, starting in 1898.

Chicago Mercantile Exchange (Photo credit: milletre)

This morning I saw a tweet about ICE purchasing $NYX and started thinking about it.

Exchanges went for profit starting with CME in 2001, and ending with $CBOE. Ever since, the action was to start merging exchanges. Merger mania happened until the financial crisis. There are several ways to look at exchange mergers. One is by how much cash flow they throw off given the investment. That’s simple financial analysis that CFO’s love to engage in. It’s up their alley. No matter the acquisition, a firm should engage in that analysis. In Microeconomics Monday last Monday we talked about the cost of producing one more. That post serves as a suitable frame to figure out if it’s beneficial for exchanges to merge.

But there is also strategy and economic projection. For example, ICE bought the Russell 2000, wresting its control from CME. When I did the numbers calculation on the purchase, ICE bought the Russell for roughly break even. I haven’t checked-but my assumption is they probably lost money on it because they haven’t grown volume. The Russell benefited from network effects of ensconcing themselves within CME’s equity quadrant.

There have been some small time transactions that furthered strategic objectives. CME bringing the KCBOT into the fold is an example of strengthening it’s hold on row crop ag futures. But remember, no matter how big the transaction, there are operational costs to bringing them in. The costs to acquire a massive exchange and a small exchange aren’t that much different.

In the case of the ICE picking up the $NYX, it’s probably more strategic than crude CFO net present value cash flow valuation. No commodity exchange wants to play in the regulatory environ of the SEC. They are a horrible regulator. Always behind the curve and always looking at things through the lens of rules not principles. Their oversight comes from a different set of politicians, and dealing with them increases operational costs. It’s one of the reasons a CME/CBOE tie up aren’t totally realistic.

For evidence of how bad the SEC is, just look at the way they manipulated regulations on single stock futures. They killed a perfectly good and needed business model by regulation because of lobbying by the stock and option exchanges.

ICE is eyeing NYX for two reasons. It’s European commodity operation (LIFFE/Euronext) and to increase its global footprint to attract customers. Costs for customers are increasing rapidly. There are huge financial and operational barriers to entry if a firm wants to be a “kahuna competitor” in the commodities business. ICE needs to begin to match CME’s scale and scope if it wants to increase volume.

The exchange business is a fixed cost business. The more volume pumped through the system, the more money that’s made. Exchanges are wonderful ATMs. Their margins are incredible because they run their businesses hyper-efficiently.

My guess is if ICE were to purchase NYX, it would be like a game of gin. They’d keep the commodities part in their hand, might also hold onto the options part to see if they could get a run going, but discard the cash equities piece because there is no value there. Owning it brings more headaches than its worth.

If I am incorrect in my analysis, it’s because customers are telling exchanges that they want to play in all four segments of the money marketplace, and have one stop shopping to do it. Only then is owning a stock exchange worth it. Exchanges setting up their own dark pools to compete is a brave new world.

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