Streetwise Professor

May 11, 2006

Exchange Speed Dating

Filed under: Exchanges — The Professor @ 4:39 am

My head spins trying to keep up with all of the rumors of this exchange talking to that exchange about a merger. Everybody seems to be talking to everybody else in very rapid succession–hence the analogy to speed dating, events where busy and available singles serially interview potential partners.

Ms. LSE seems particularly popular, but somewhat coy. Mr. CME has money falling out of his pockets, but really wants to find Miss Right. Herr Deutsche Borse got badly burned in his courtship of Ms. LSE, and is making overtures to the girl next door–Mlle. Euronext.Liffe, who wants things definitely on her terms or not at all, and seems to have major reservations about Herr DB. Ms. CBOE needs to get completely moved out of her dad’s (Mr. CBOT) house before she can commit. The mature bachelor freshly on the market–Mr. NYSE–appears a little unsure on what to do, but seems to be looking for someone who is very different.

At the end of the night, who will end up with whom? Beats me, but here are a few thoughts.

First, don’t be surprised to see a few mistakes made, as is wont to happen when there are strong expectations that one should really be married by now. Some exchanges are swimming in free cash flow, and it is well known that this sometimes leads to ill-advised purchases. Marry in haste, repent in leisure.

Second, look for economies of scope and scale. As noted in the just-previous post, NYMEX-CME makes sense. CME-Euronext.Liffe also has some attractions given their complementary derivatives products–both are strong in short term interest rate (STIR) products. But both have good technology platforms, so it’s hard to see what they gain from the pairing on that front. And inter-cultural marriages are always a challenge. The scope economies between derivatives (especially futures) and equities don’t strike me as compelling, but I could be wrong. There is a superficially plausible case for combining an exchange that offers individual equity options with an equity exchange, but again I don’t find it compelling. There are potential advantages to trading equities that are currently traded on different exchanges on a single platform, so an equity exchange + equity exchange merger (e.g., NASDAQ+LSE, NYSE+Euronext) may make sense, although they may face some daunting issues regarding integration of their trading platforms. In futures, the big savings come from the clearing side, and potentially the technology side. CME and CBOT have already combined clearing, so a merger between them doesn’t bring a lot of savings on the clearing end. Moreover, there may be some nettlesome legal issues involved in integrating clearing for a US and a European exchange.

In brief, nothing jumps out at me as a no-brainer. Hence, as I’ve often said in the past, don’t believe stories of exchange marriages until you see the rice fly.

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