Saturday, December 22, 2012

ICE -- the mouse that roared -- takes on the Big Board

    In the year 2000, a tiny little upstart energy exchange was born in Atlanta, Georgia. It began by building an electronic trading system for electricity and natural gas, something that was a popular idea at the time.

But it was – perhaps – before its time.

So the InterContinental Exchange cast its eye over the markets to find something with a little more liquidity. Maybe something that could benefit from its technological prowess. ICE spied a very interesting energy exchange on the other side of the Atlantic and engineered a surprising – to the City of London, at least - takeover.

     When ICE bought the International Petroleum Exchange in 2001, no one in the oil business could imagine life without the IPE floor. The idea of oil trading on an electronic exchange was considered heresy. “Impossible,” traders said.

     The thought was that since oil is the game of professional traders, and not mom and pop investors, the floor broker was essential to the game. Swaggering, hard-drinking and mainly Cockney in origin, the IPE floor brokers were considered a permanent fixture in the business.

     IPE’s own automated trading system had gone through many technology iterations and was never up to the task, in many traders’ opinions. So, like a lion stalking the weakest wildebeest, ICE swooped in.

It transformed the International Petroleum Exchange, second only to the New York Mercantile Exchange in terms of energy futures trading, seemingly overnight--from an open outcry “pit” into a sophisticated electronic trading venue. Cockney brokers out, computers in.

     The IPE’s membership and operators should have learned a lesson from their LIFFE brethren, whose massive open outcry trading floor was closing down at the time - pit by pit. LIFFE’s main competitor – Deutsche Borse, had gone electronic with its derivatives trading and was walloping LIFFE. LIFFE’s state-of-the-art floor closed doors in November 2000, while its LIFFE Connect electronic trading system went from strength-to-strength.

     The LIFFE exchange itself sold to Euronext, eventually ending up in NYSE’s hands along with the very valuable acquisitions LIFFE had made along the way. This included the London Commodities Exchange, where softs such as coffee, sugar and cocoa were – almost exclusively – traded.

But ICE’s CEO Jeff Sprecher was not daunted by his competition. His dogged determination to make all things electronic took ICE into clearing in a big way, adding the capacity for clearing OTC credit default swaps, and into diversifying its products offerings. ICE’s dominance in markets from oil to interest rates and credit derivatives prompted NASDAQ in 2011 to choose ICE as its partner in its failed bid for NYSE.

     The fact that ICE persevered with its electronic trading platform, making it ever-faster, offering clearing electronically – is probably why it had the money and the ability to buy the venerable New York Stock Exchange and its many acquisitions. I am sure that during the due diligence process, ICE had a good look at NYSE’s hodge-podge of trading systems and infrastructure.

     NYSE members and management had initially resisted the seismic shift to electronic trading, preferring its image as the bastion of Wall Street with its colorful floor brokers and trading pits and specialists. It adopted a hybrid model of automated-cum-open-outcry trading, buying--and then largely ignoring--state-of-the-art trading systems such as ARCA. Aggressive all-electronic competitors such as NASDAQ and newcomers including BATS stomped all over NYSE’s model, gradually eating away at the Big Board’s once-dominant market share.  

     ICE was lurking in the underbrush. Sprecher’s strategy of diversification meant that he needed to further integrate other asset classes, which – once siloed were now tightly correlated with oil trading. Equities, interest rates, foreign exchange, and agriculturals such as corn and sugar were suddenly noticeable as a necessary adjunct to oil futures and swaps trading.

     Limping from its market battering by electronic competitors, NYSE Euronext was the weakest wildebeest.

     Since 1792, when it was formed under a buttonwood tree on Wall Street, the New York Stock Exchange has captured the imaginations of people around the world. It has attracted some of the best and brightest young people to work on Wall Street, conjuring up an image of stolidity and grace.

     Now, although the NYSE brand will remain, ICE will become the top dog. New York City must be stunned that it has lost its bulwark stock exchange to a jumped-up little technology upstart from Atlanta.


  1. There are some parallels here with the Hong Kong Exchange (HKEx) purchase of the venerable London Metal Exchange (LME) earlier this year (and just ratified by the FSA). The LME has the last open outcry trading pit in Europe, and HKEx has promised to leave the model unchanged until 1 Jan 2015. LME does already have telephone and online trading facilities, however it's the 5 minute sessions per metal in the pit that set the official prices. Are there any bets that the pit will still exist after the clock's pendulum swings from 2014 into 2015? I doubt it.

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