Securities Exchanges: Technological Issues In Focus, ICE Makes Another Acquisition

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As always, the U.S. exchange sector remains a hotbed of activity. According to recent news, NASDAQ OMX (NASDAQ:NDAQ) and NYSE may soon reach an agreement to back up each other’s data feeds. The unprecedented move is likely to reduce the possibility of tech-related market shutdowns, which have occurred frequently over the last few months. [1] Meanwhile, CME group (NASDAQ:CME) seems to be having its own technical problems. The exchange reported recently that its computer systems were hacked in July, and some customer data was compromised. [2] On the M&A front, activity continues to happen as IntercontinentalExchange (NYSE:ICE) acquired the Singapore Mercantile Exchange within days of completing the purchase of NYSE Euronext. [3]

A Positive Step Towards Solving Technical Problems, But System Is Still Vulnerable

The U.S. financial system has had at least five major technology-related outages since August this year, and all the major players in the industry were involved in at least one of them. BATS Global witnessed technological issues on August 6 and September 26, while trading on NASDAQ had to be stopped on August 22 and September 4, again due to technical problems. NYSE also faced a computer related outage on September 16.

The visible rise in technology-related errors not only impacts the confidence of market participants in the strength of the U.S. financial system, but has also changed the risk perception of the whole exchange sector. In September, rating agency Standard and Poor’s warned that it would consider downgrading a few players in the industry if such outages continue to occur. [4]

In light of the above facts, we believe that the collaboration undertaken by NASDAQ and NYSE will be beneficial for both the players, as well as the whole industry. However, the recent cyber-attack on CME underscores the fact that exchanges are still a long way from being impervious to technological mishaps, caused intentionally or otherwise. Reuters reports that almost half of the securities exchanges in the world were targeted by cyber-attackers last year. We believe that this makes a strong case for exchanges to make continued investments in technology.

Investments In Technology Could Force Fees To Go Up

As exchanges continue to invest in new systems in order to avoid embarrassing seizures or break-ins, their operational costs are likely to increase. In the short term, they could absorb these expenses and live with lower margins, but at some point of time they will have to pass on the costs to end users by increasing prices. The trend might have already started, as CME announced its first major price hike since 2009 on November 12, citing the investments it made in “resources and technology enhancements to address the growing infrastructure needs for [its] customers”. [5] (read: Pricing Structure Changes Likely To Push CME’s Revenue And Margins Higher)

Industry Consolidation Remains A Strong Trend

The global securities exchange sector remains very dynamic and has been seeing a significant amount of consolidation of late. This was demonstrated during the past week, when ICE announced that it would purchase Singapore Mercantile Exchange (SMX) for $150 million. The announcement came within days of the completion of its NYSE Euronext acquisition, and highlights the rapid pace at which some of the large players are trying to expand.  SMX provides ICE the ownership of an exchange and a clearing infrastructure in Asia for the first time. ICE’s chief strategist, David Goone, highlights that trading activity in the exchange’s benchmark energy and interest rate products has been increasing in Asia for the past few years, making it a lucrative market. [6] Given the opportunity, we would not be surprised if other players, such as CME, also start showing interest in the region in the coming years.

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Notes:
  1. NYSE and Nasdaq Plan to Back Up One Another’s Data Streams, WSJ, November 15, 2013 []
  2. UPDATE 1-CME Group says swaps clearing service was hacked in July, Reuters, November 16, 2013 []
  3. ICE acquires Singapore Mercantile Exchange and clearing house, BankingTechnology, November 19, 2013 []
  4. Exchanges’ Technical Glitches Reveal Growing Operational Risk–And Could Trigger Downgrades, S&P, September 19, 2013 []
  5. CME defies trends by hiking trading fees, FT, November 12, 2013 []
  6. ICE (ICE) to Acquire Singapore Mercantile Exchange, Street Insider, November 19, 2013 []