Streetwise Professor

June 17, 2007

NYMEX on the Block

Filed under: Exchanges — The Professor @ 10:01 am

In Whither NYMEX and Merc+Merc I surmised that NYMEX would not survive long as an independent entity. Earlier this week, that conjecture came much closer to reality. The exchange’s Chairman, Jim Newsome, made remarks that put NYMEX in play. Then Bloomberg’s Matthew Leising broke a story saying that NYMEX was in preliminary talks about a sale with three exchanges–Deutsche Borse, the NYSE, and CME.

NYMEX has strengths–its energy futures franchise–and weaknesses–notably the fact that it does not own its electronic trading platform. Each of the named suitors can fix the latter problem.

Who is going to prevail? I would put DB a distant third. Its activist shareholders (e.g., Atticus Capital) have been sharply critical of the exchange’s run at the LSE, and its offer to purchase the ISE. If they are furious with the $2.8 billion offer for ISE, I imagine they would be apoplectic over shelling out $14 billion or so for NYMEX.

CME is the most natural fit. NYMEX contracts already trade on GLOBEX (with 80 percent of crude contracts traded electronically on that platform.) This would dramatically reduce the integration problems. Moreover, a combination with CME would generate additional scope economies in clearing.

The NYSE’s John Thain has made it abundantly clear that he wants to buy his way into the derivatives market. Given the increasingly competitive environment in equities post RegNMS, and the continued spiraling growth in derivatives, this is very wise. NYMEX would be a good–but very pricey–way to do that. NYSE has the dough to deal. There could be some decent clearing economies via LCH.Clearnet. The integration might be somewhat dicier than with CME, but probably not an insuperable obstacle. But I think the main thing is that NYSE is going to do what is necessary to buy a big derivatives exchange–including overpaying for one. I get the sense that CME is not going to overpay just to do a deal, so the NYSE’s intense desire to get into futures could be decisive.

So, this could turn into an interesting battle between two heavyweights–NYSE and CME. How will it turn out? Here are my thoughts.

First, things will get very interesting after July 9, when the CBT and CME shareholders vote on the merger. This will resolve a lot of the uncertainty that makes prognostication difficult. If, as I expect, the shareholders approve, CME could well turn its sights on NYMEX. This could set off the battle with NYSE. Or, more likely in my view, NYSE will turn its gaze to ICE. Thus, the most likely scenario in my view is that there will be a CME/CBT/NYMEX combo and a NYSE/ICE pairing.

Second, things could get crazy if CBT shareholders reject the CME offer. If ICE gets CBT (no certainty), CME could turn immediately to NYMEX, or CME could try to swallow ICE. Or NYSE could go after ICE. I still think that the advantages of a CME-CBT combination are so compelling that one way or the other that the CME will get CBT, perhaps with ICE in the bargain. If that happens, NYSE would likely end up with NYMEX.

Third, after July 9th, it is likely that CBOE’s status will become clearer. Once the issue of CBT member trading rights on CBOE is resolved, CBOE will be in play. I think that it will end up with NYSE.

Fourth, once NYSE buys a US futures exchange–whether it’s NYMEX or ICE–it will be interesting to see how that changes the regulatory dynamic in the US. Securities exchanges and derivatives exchanges have always been at loggerheads over regulatory issues. Futures exchanges have wanted to stay away from anything that would put them under SEC oversight. Indeed, this is one reason why CME has disavowed any interest in CBOE. Once the NYSE gets a futures exchange, it will be interesting to see whether their attitude towards the SEC, and their support of a single regulator of stock and futures markets, will change. I imagine that it very well may. This is a very complicated issue, and there is no way that I would venture bold predictions. Suffice it to say that the consolidation of exchanges, and specifically the convergence/consolidation of derivatives and securities exchanges, will have major effects on US regulation.

In sum, we are nearing the culmination of the restructuring of US exchange markets. The weeks and months following July 9 will see a profound, and in my view rapid, reorganization of these markets. Moreover, the Road to the Final Two (exchanges) will run through Chicago because a major likely acquirer–CME–and a major likely target–CBOE–are there. (Yeah, I know it will run through New York too because major acquirers and targets are there too, but I gotta give props to my home town.) My bet is that when the dust clears, we’ll see CME+CBT+NYMEX and NYSE+ICE+CBOE.

[One aside. What about the two remaining US futures exchanges, MGE and KCBOT? They’ve done pretty well lately, but on purely economic grounds, in an electronic era it doesn’t really make sense that they remain independent entities. But their survival was always something of an anomaly anyways. CBT could have probably put both out of business by offering competing wheat contracts any time it chose. But it didn’t. Why not? Politics is a likely explanation. The value of the MGE and KCBOT to the CBT as political allies with influence on the Minnesota and Missouri congressional delegations far outweighed any value that the Chicago exchange would have gained by taking away volume from their relatively small wheat contracts. That might change once NYSE gets into futures. That would transform the NYSE from a political adversary of the Chicago exchanges to a frequent political ally. With the NYSE’s clout added to Chicago’s clout, the political value of the Minneapolis and KC exchanges will decline precipitously. If my political economy explanation for their survival to this point is correct, I would expect their days as independent exchanges to end soon after NYSE gets into futures in a big way, and sees its future growth coming more from derivatives than equities.]

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