NYSE/Deutsche deal sees value in derivatives

The planned merger between exchange operators NYSE Euronext and Deutsche Börse will create a derivatives powerhouse, as the cash equities market declines in importance as a revenue stream.
By None

The planned merger between exchange operators NYSE Euronext and Deutsche Börse will create a derivatives powerhouse, as the cash equities market declines in importance as a revenue stream.

In a letter to the European Parliament sent on 10 February 2010, Dominic Cerutti, president and deputy CEO of NYSE Euronext, said that the merger between his firm and the German exchange was “among the possible responses to the need for a competitive rebalancing between regulated markets and alternative platforms”.

Competition has successfully cut into the market share for traditional stock exchanges. NYSE Euronext's market share of US volume has fallen from 36.2% in 2008 to 29.7% in 2010 according to data from NYSE Arca, an electronic market which is part of the NYSE Euronext firm. According to data provider Thomson Reuters, NYSE Euronext has seen its market share drop from 22.5% to 15.24% in this period – Deutsche Börse from 17.47% to 11.4% – across pan-European equities trading.

Equities turnover has started to recover since the financial crisis – in Europe it fell from €24 trillion (US$32.4 trillion) in 2008 to €15.4 trillion (US$20.8 trillion) in 2009 before recovering to €19.88 trillion (US$26.86 trillion) in 2010 according to Thomson Reuters. NYSE Arca has tracked US equity trading volumes falling from US$75 trillion in 2008 to US$55 trillion in 2009 before recovering to US$59 trillion in 2010.

But the crash took its toll. From 2007 to 2009, Deutsche Börse's combined revenues for primary and secondary equity markets fell from €435 million (US$589 million) to €251 million (US$340 million). The London Stock Exchange (LSE) saw a fall on its secondary markets from £184.2 million (US$297 million) in 2008 to £133.5 million (US$215.3 million) in 2009.

US and Nordic market operator Nasdaq OMX’s secondary market figures dipped from US$366 million in 2008, to US$244 million in 2009 recovering to US$255 million last year. NYSE Euronext's secondary market revenue dropped from US$2.387 billion in 2008 to US$2.204 billion in 2009 recovering to US$2.471 billion in 2010.


The lesson learned over this period is that diversity offers exchanges a more secure business.

NYSE Euronext's secondary markets are providing a lower proportion of revenues than ever before, falling from 51% of total revenue in 2008 to 28% in 2010. In the same period derivatives and clearing grew from 20% (US$919 million) to 25% (US$1.088 billion) of revenues and IT and services from 3% (US$160 million) to 10% (US$444 million) of revenues. At a press conference on 8 February 2011, the NYSE Euronext revealed that it expects its technology division to grow by 15% in 2011. It has also set a revenue target of US$15 billion by 2015 for its information services and technology solutions section overall.

The LSE has long made a virtue of its investment in IT services, which had increased from 5% of revenues in 2008 to 7.5% in 2009. Xavier Rolet, CEO, said that selling technology on to other exchanges would be an important part in its merger with Canadian exchange operator TMX, which would make it a “powerful, third competitor” to NYSE Euronext and Nasdaq OMX both of which sell their trading systems to developing markets exchanges. Rolet has asserted his intention to expand the derivatives business of the merged entity. However the potential for the LSE/TMX combined offering is dwarfed by that of a joint NYSE Euronext/Deutsche Börse proposition.

Initially the German/French/Benelux/US business will see cost savings through rationalisation of operations. “Deutsche Börse has a cost reduction programme across the firm and it is facing the question of when it is going to replace Xetra, its trading platform. I think part of the rationale of the NYSE Euronext deal is to not have to replace Xetra but actually just to use NYSE Arca, which is a splendid system for equities,” says Dirk Hoffman-Becking, senior research analyst at sell-side research firm Sanford C. Bernstein, referring to the rival platform that NYSE bought in 2006.

“The operational savings are a lot more substantial than would be achieved by the LSE/TMX deal,” adds Herbie Skeete, managing director, at exchange information supplier Mondo Visione.

The costs involved in NYSE Euronext's previously announced plan to develop its own equities and derivatives clearing houses, announced in 2010 and aimed to complete in 2012, could be saved through the adoption of Deutsche Börse's Eurex Clearing operations. “The joint derivatives and clearing business is clearly a good thing and ticks quite a few boxes for what regulators want on both sides of the Atlantic, with more OTC trades being cleared and traded on a regulated platform,” says Skeete.

This would also reduce overall trading costs, adds Hoffman-Becking. “The amount of margin I have to put in place depends on the net risk position I end up with at the end of the day. If I have the two platforms combined, I have to put less margin and less capital – hence trading becomes more effective and cheap, so I'll trade more,” he says.

Derivatives prime

The group's combined derivatives businesses, Eurex and NYSE Liffe, have little crossover and so could dominate the market if combined, says Skeete. “They will push Chicago Mercantile Exchange into second place. They will go head to head for global domination and that leaves the LSE even more in the cold.”

However to ensure that the deal does not breach monopoly rules, it is possible that NYSE Liffe, which the LSE itself contemplated buying in 2001 when it was a standalone exchange, could be separated and sold off from the rest of the merged entity. That could offer a second chance for the LSE. “The LSE haven’t got a derivatives segment to speak of. TMX has the Montreal Exchange and a stake in Boston Options Exchange, but they are small beer compared to NYSE Liffe and Eurex. It shows the weakness in the LSE and that losing Liffe was careless on its part,” Skeete notes.

A voice that is yet to be heard is Nasdaq OMX, a rumoured bidder in the recent contest for multilateral trading facility (MTF) Chi-X Europe, now in exclusive discussions with exchange and MTF operator BATS Trading. Nasdaq OMX has seen revenues from derivatives and clearing increase from 9% (US$129 million) in 2008 to 17.4% (US$256 million) in 2010 while IT and services grew from 8% (US$119 million) to 10% (US$152 million). A counter-bid to one of the proposed mergers is still a possibility.