Once the acquisition of NYSE Euronext (NYSE:NYX) by the IntercontinentalExchange (NYSE:ICE) is complete, the combined entity is likely to focus on profitability even if that means losing market leadership in certain businesses. Speaking at the Sandler O’Neill Global Exchange & Brokerage Conference, Jeff Sprecher, CEO of IntercontinentalExchange, said that he would be willing to give up some of NYSE Euronext’s market share in the U.S. equity trading business in order to end prevalent trading incentives.
Trading incentives are used by exchange operators to attract order flow and enhance liquidity. They often prove useful in keeping volume market share intact. However, this comes at a cost, as trading incentives reduce an exchange’s profit margin. Sometimes an exchange may actually be paying more in incentives for a trade as trading fees on it than what it earns.
Mr. Sprecher believes that paying for order flow is “ridiculous” and that NYSE, being the market leader, should set an example by not doing so, even though it is likely that the exchange would lose a “lot of market share” in the process. He says that he welcomes competitors to take money-losing business off NYSE’s books.
The statement comes shortly after the shareholders for both, NYSE Euronext and ICE approved the acquisition last week. Barring regulatory blockades, the acquisition should be completed sometime in the third quarter of 2013.
NYSE Euronext Could Have A Much Smaller Footprint
It is already well known that the IntercontinantalExchange is actually interested in NYSE Euronext’s European derivatives business and not in the exchange’s low-margin U.S. equity business. The European derivatives market is set to grow rapidly over the next few years as regulations force OTC contracts to be centrally cleared, and being one of the two market leaders, NYSE’s European derivatives business called LIFFE, provides IntercontinantalExchange an ideal opportunity to quickly scale up its offerings in that market.
On the other hand, the U.S. Equities business has low profit margins and is not complementary to the IntercontinantalExchange’s current business. In some sense, it comes as a tag along in the process of acquiring LIFFE.
Given the above information, it seems natural that the IntercontinentalExchange looks to maximize the profitability of this business and is not concerned about losing market share. NYSE Euronext’s U.S. cash trading and listing franchise earned $1,572 million in transaction and clearing fees in 2012, and reported expenses of around $896 million over the same period as liquidity payments, routing and clearing fees. This suggested that liquidity payments comprise a large part of the business’ direct expenses, and if eliminated, would impact its profitability significantly.
Why Not Sell The U.S. Equity Business?
This thought may have already crossed your mind when we mentioned that the U.S. equity business has no synergies with the IntercontinentalExchange and would in fact be a drag on its profit margin once the acquisition is complete. The company is already in the process of offloading several non-core business units and it does not seem unimaginable that the U.S. equity business would eventually be divested. (The non-core businesses currently on the block are Euronext, NYSE Technologies and NYSE’s stake in MCX)
We believe that this could happen once the macroeconomic environment improves and trading volumes revive. The business has been battered by low trading volumes in the past few years, and the new owner is likely to wait for conditions to improve in order to get a better valuation for the business. Further, the eventual divestiture of this business, if it happens, is most likely to be in the form of an IPO because anti-trust laws disallow major competitors from acquiring it.
In any case, trying to improve the division’s profit margin seems like a positive step for the company’s shareholders.