Why the NYSE doesn’t matter

By Felix Salmon
December 20, 2012

It’s official: ICE, an Atlanta-based commodity derivatives exchange which few Americans have ever heard of, is buying the New York Stock Exchange, without much indication that it even cares about the New York Stock Exchange. (The real reason that ICE wants the company is Liffe, NYSE Euronext’s London-based financial derivatives subsidiary.) If all goes according to plan, ICE will happily jettison the Euronext half of NYSE Euronext.

To get an idea of the degree to which stock trading is a complete afterthought in this deal, look at yesterday’s big merger announcement that Getco is buying Knight. That deal is valued at $1.4 billion, or about 17% of the price being paid for NYSE Euronext. And in many ways the new Getco-Knight combination is going to be bigger and more important, when it comes to stock trading, than the NYSE Group.

To put it another way: we’re living in a world where stock traders have become stock exchanges (both Getco and Knight control massive “dark pools”), while stock exchanges have become derivatives exchanges where the equities business is basically a high-profile, low-profit branding exercise. The NYSE Group is now just going to be a subsidiary of ICE; in the official announcement, which talks about its “iconic trading floor”, you can almost hear ICE CEO Jeffrey Sprecher rolling his eyes and wondering why on earth he needs to hang on to what at this point is little more than a heavily-guarded tourist attraction. (The release also made sure to note that ICE’s own New York offices are going to be miles away, in midtown Manhattan.)

It’s actually a good thing that stock trading has become a low-margin, low-value business: that’s what’s meant to happen when you have lots of competition. Think of it as one of the few areas of the financial-services sector where capitalism works as advertised. Elsewhere, we still have enormous salaries and enormous margins, which is one reason that ICE and CME between them are going to have a market capitalization of well over $30 billion by the time this merger is done.

Exchange mergers, then aren’t actually boring at all: they’re an indication that the financial-services industry is desperately trying to protect the rents it can collect by means of consolidation. There are lots of stock exchanges, and none of them make much money. By contrast, there are relatively few derivatives exchanges, they tend not to compete directly with each other, they tend not to compete on price, and they’re wildly profitable.

That’s something worth remembering, next time you hear about “Wall Street pay”. Yes, people on Wall Street do make stratospheric sums of money. But they’re very unlikely to make those sums by trading stocks on the New York Stock Exchange: there are much greater riches to be found trading derivatives on exchanges in London or Atlanta or Chicago. Just ask Lloyd Blankfein. He started his Goldman Sachs career trading commodity derivatives at J Aron. And just as the derivatives exchanges now dwarf the stock exchanges, so do the derivatives superstars now control banks like Goldman.

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My understanding is/was that ICE was originally a creation of the NY investment banks for the express purpose of combating the inroads into derivatives trading (their bread & butter) then being made by the CME.

Getco may be paying too much for Knight.

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