TCS Daily


Financial Markets Get Global

By Dominic Basulto - June 20, 2006 12:00 AM

NYSE Group's $10.2 billion merger bid for Euronext NV, the operator of the Paris, Amsterdam, Brussels and Lisbon stock exchanges, has the potential to create the world's largest transatlantic stock exchange (assuming, of course, that Deutsche Borse doesn't try to spoil the bid). In a financial world that is increasingly globalized, the New York Stock Exchange had no other choice than to embrace what the Wall Street Journal has called "a new era of global stock trading."

In a span of just a few years, the New York Stock Exchange (NYSE) has fundamentally altered its business model to embrace everything from electronic trading to derivatives to global stock listings, while at the same time becoming a publicly-traded entity responsible to its shareholders.

While globalization has brought wrenching change to nearly every corner of the global financial services industry, the NYSE was largely shielded from the competitive forces in the marketplace by a non-profit management structure. In addition, until recently, the NYSE was headed by a top executive -- Dick Grasso -- who cared more about pay perks than about transforming the NYSE into a world-class competitor. Since 2004, when John Thain took over as CEO, it looks like the NYSE has finally turned the corner as it grapples with the realities of globalization -- but is the NYSE up to the task of playing innovation catch-up with the rest of the world?

In other industries, the rapid pace of globalization has been measured by the number of jobs lost to overseas competitors such as India and China. In the world of financial exchanges, the pace of globalization has been measured by the number of stock market listings that have been lost to overseas competitors in places like London and Hong Kong. As CNBC commentator Jim Cramer recently pointed out, 23 of the 24 firms recently looking to raise more than a billion dollars in capital chose to list overseas rather than in the U.S. For Chinese companies looking to raise billions of dollars from global investors, Hong Kong -- not New York -- is now the preferred venue.

With this in mind, the key to global competitiveness for the NYSE will be its ability to come up with innovative new products and services that will attract global capital flows. Along the way, the NYSE will need to speed up the transition to an all-electronic trading platform to replace its clumsy hybrid model (i.e. part open-outcry, part electronic) that it cobbled together after a merger with all-electronic exchange Archipelago. While the NYSE dragged its heels on electronic trading as a way of making efficient, orderly markets in listed stocks, equity and derivatives exchanges in London, Tokyo, Hong Kong, Sydney and various capitals of Europe have embraced electronic trading for years.

In terms of product innovation, the NYSE must respond to the phenomenal growth in the global derivatives markets. In fact, some commentators have noted that the NYSE is really buying Euronext as a way to enter the booming European derivatives business, and not just as a path to global stock listings. Through its stake in Euronext.liffe, the European exchange operator is responsible for about 40 percent of trading in Europe's $16 trillion derivatives market. In contrast, the NYSE has only a 10 percent share of U.S. derivatives trading, courtesy of last year's Archipelago deal. As a result, the NYSE is rushing to create new hedging and risk management products, such as credit derivatives, that will trade in New York.

This ability to innovate will become even more important since the NYSE is now a publicly-traded entity. Just like any other publicly-traded company, the NYSE must heed its shareholders, who will demand top-line revenue growth and the continual launch of new products and services that will boost shareholder value. Just as major U.S. companies are embracing innovation and creativity as they attempt to reverse the effects of globalization, the NYSE must embrace innovation as it reclaims its role as one of the world's most attractive destinations for capital.

To understand how important product innovation is to the long-term health of the New York Stock Exchange, consider the market valuations of the NYSE and Chicago Mercantile Exchange (CME). A casual observer might assume that the market valuation of the NYSE would dwarf that of the CME, which deals primarily in financial derivatives. In fact, the CME currently has a market valuation of $17.2 billion, compared to a market valuation of only $11.5 billion for the NYSE. According to one Morningstar analyst, in fact, the CME is "the world's greatest business." In other words, as the result of technological advances, trading in derivatives appears to be a better business than traditional stock trading.

It will be interesting to watch the next steps in the ongoing consolidation of the world's financial markets. With the NASDAQ acquiring a 25 percent stake in the London Stock Exchange and the New York Mercantile Exchange linked in rumors with the Toronto Stock Exchange, it's clear that U.S. financial markets are finally realizing that globalization can be an opportunity, and not just a threat. In this globalized world, the winners will be those that embrace financial innovation and create less onerous regulatory regimes for investors.

Dominic Basulto is a TCS contributor who writes frequently about finance and technology. He is also the editor of the Business Innovation Insider.

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