Here’s What NASDAQ’s ETF Move Means For NYSE Euronext

Exchange-traded products are a large segment of the securities industry and NYSE Euronext (NYSE:NYX) controls a dominant market share in trading these investment vehicles through its Arca exchange. However, NASDAQ OMX (NASDAQ:NDAQ) is making serious efforts to steal some volume away from NYSE.

Last month NASDAQ filed a petition with the regulators to convert its PSX platform into a marketplace solely dedicated to trading exchange traded funds (ETFs). PSX is NASDAQ’s smallest trading venue by volume. ^[1] If the exchange operator gets the required approvals from the SEC, we could see action in this market as soon as the second quarter of 2013.

Why Does It Matter?

According to our estimates, over 60% of NYSE’s revenues are dependent on equity trading volumes, of which ETFs account for a significant and growing portion. ETFs are the most popular type of exchange traded products (ETPs) and trading of ETPs accounts for over 15% of total equity trades in the U.S. The percentage was even higher in 2009 when ETPs accounted for over 20% of total equity volumes in the U.S., according to data reported by NYSE. ^[2]

NYSE’s cash trading and listings business, of which ETF trading is a part, accounts for 45% of our estimated stock price value for the company. You can see our price estimate and NYSE’s important business drivers in the interactive chart below.

See our full analysis for Nasdaq OMX| NYSE Euronext

How Big Is The ETF Market?

According to data obtained from NASDAQ OMX, a total of 238 billion ETF shares were traded in the U.S. in 2012, their lowest level in the last five years. At their peak, a total of 462 billion ETF shares were traded in the U.S in 2009. ((NASDAQ’s ETF Marketshare statistics, February 2013))

Further, our estimates suggest that NYSE and NASDAQ make $3.18 and $3.19, respectively, as trading fees for every 1,000 shares traded on their platforms. These two estimates are very close to each other and we will use the lower number to estimate the total ETF trading market size.

Using a rate of $3.18 per 1,000 shares traded, we estimate that the current market size of ETF trading is around $757 million. Further, the ETF market size would be almost double, at nearly $1.5 billion, if trading volumes were at their peak of 462 billion.

Why Do We Think ETF Volumes Can Improve?

The above analysis suggests that the ETF trading market could almost double if trading volumes were to rebound to their peak levels. Here are some reasons why ETF trading is likely to improve in the future:

ETFs Remain Popular Despite The Trading Blues

ETFs are particularly promising because they have not fallen out of favor among investors even though overall investor enthusiasm has been low. Investors poured in a record $188 billion into U.S.-listed ETFs in 2012, surpassing the previous record of $175 billion in 2008. ^[3]

The fact that ETF trading volumes are at a five-year low even when investors are pouring record levels of assets into these products indicates that investors are currently pursuing a buy-and-hold strategy. However, sooner or later, these investors will begin to rebalance their portfolios and ETF trading should pick up.

Younger Investors Like ETFs

Recent research by TD Ameritrade (NYSE:AMTD) suggests that there is a strong correlation between age and ownership of ETFs. Investors in the age group 26 to 35 keep almost 12.7% of their assets in ETFs, which is nearly double the allocation by investors who are 66 to 75 years old. ^[4]

As intergenerational wealth transfer occurs and more young people become wealthy, we could expect a gradual movement of assets to ETFs and increased trading in these investment vehicles.

Retirement Funds Favoring ETFs

Another important factor that is likely to ensure that ETFs remain in vogue is the new regulations in the retirement space.

The Department of Labor’s new rules require better transparency of fees in retirement plans. This requirement is likely to push several employers and 401(k) retirement plans to incorporate cheaper investment vehicles  — like ETFs — into their portfolios.

Retirement plan providers like Charles Schwab (NYSE:SCHW) are already developing ETF-only 401(k) plans to exploit this opportunity and similar innovations in the retirement industry are likely to increase the popularity of ETFs. You can read more about some of these developments here.

What We Are Watching?

Going forward, it will be interesting to see how much traction NASDAQ’s PSX platform is able to generate in the ETF market. As of February 2013, the US ETP daily average turnover on NYSE Arca was approximately $59.1 billion. ^[2] By those standards, NASDAQ PSX has a lot of ground to cover.

However, ETFs are relatively new products and if NASDAQ is able to attract the trading of some popular ETFs, we can expect it to increase its market share quickly. The exchange may try to attract volumes by undercutting NYSE on trading fees.

We will also be closely watching any moves that NYSE makes to abate the threat from NASDAQ.

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1. Nasdaq Plans to Focus on EFTs With PSX Exchange, WSJ, March 12, 2013)

   More recently, NASDAQ filed a request with the SEC to change PSX’s order matching priorities to suit ETF trading. ((Nasdaq Files to Change Order-Matching Priorities on PSX, Trader’s Magazine, March 22, 2013 [↩]

2. Monthly U.S. ETF Factsheet, NYSE [↩] [↩]
3. US ETF Inflows Hit A Record $188B In 2012, Yahoo Finance, January 2, 2013 [↩]
4. ETFs are millennials’ BFFs, MSN Money, March 28, 2013 [↩]