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TitleElectronic Exchanges: The Global Transformation from Pits to Bits
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Table of Contents
                            Cover Page
Copyright page
	Copyright page
An Era of Creative Destruction
	An Era of Creative Destruction
		Trading: Simple Concept, Complex Process
		The Birth of Exchanges
		Open Outcry Trading
		The Clearing and Settlement Process
		Technology and Its Impact on Financial Markets
		The Decade that Changed the Financial World
		The First Electronic Market
		Electronic Communication Networks and U.S. Equity Markets
		Technology Advances in the Financial Industry
		The Transformation of Exchanges: Basic Themes
			Floor to Screen
			Private Club to Public Company
			National to Global Competition
			Smaller to Larger
		Implications of the Transformation
The Four Basic Transformations
	The Four Basic Transformations
		From Floor to Screen: The Electronic Pioneers
				INTEX: The Forgotten First Electronic Derivatives Exchange2
				New Zealand and the Wool Guys6
			OM: The First Successful Screen-Based Exchange
			Melbourne Tries Screens12
			SOFFEX: Unexpectedly Electronic
			DTB: The Other Half of the World’s Biggest Exchange
			SOFFEX + DTB = Eurex
			SAFEX: An Electronic Success from an Unexpected Corner of the World19
			Asian Early Adopters
				China as an Early Adopter21
Floor to Screen: The Second Wave
	Floor to Screen: The Second Wave
		Late Arrivals Get Absorbed
			The Glitch that Wasn’t
		Last to the Party
			The After-Hours Approach
			CBOT Can’t Make Up Its Mind
			Chicago: The Final Push
			New York: The Final Push
		Stock Exchanges Move to Screens
			Nasdaq: Early, But Not All the Way
			London’s Big Bang
Floors to Screens: Nuts and Bolts
	Floors to Screens: Nuts and Bolts
		The Financial Trade Cycle
			Front Office
			Middle Office
			Back Office
		Electronic Trading Architecture
		Side-by-Side and Hybrid Systems
		The CBOE’s Hybrid System6
		New Players Solidifying the Single-Screen Concept
From Private Club to Public Company
	From Private Club to Public Company
		The Member-Owned Exchange: The Good, the Bad, and the Ugly
			Good for the Members
			Managing Regulators
			Jawboning Liquidity for New Markets
			Was It Good for the Customers?
			Problems with Mutual Exchanges in India: The Government Creates a Demutualized Competitor
			Cracks in the System: Drivers of Demutualization
			First Step: Demutualization
			The Demutualization Process
			What Is an Exchange Membership?
			Demutualization and the Transformation of a Membership
			Case Study: CME Demutualizes
			The Economic Value of Demutualized Membership
			CBOE: An Interesting Speed Bump
			The Energy Giant Demutualizes
			The NYSE Buys Public Company Status
		The Last Step: The IPO
From National to Global Competition
	From National to Global Competition
		Securities vs. Derivatives Exchanges: Fees and Revenues
		Local to Regional Competition
		Competition and Clearing
		Competition in Options
			Enter the ISE
			The Battle over Index Options
		Global Competition: The Past
			SIMEX Was Born Global
			Global Competition in Equities Via the Depository Receipt
		The New Global Competition—Kill the Competitor
			Eurex Tries to Kill the Chicago Exchanges
			ICE Tries to Kill NYMEX
			The New Global Competition in Equities
Smaller to Larger: Through Organic Growth and M&A
	Smaller to Larger: Through Organic Growth and M&A
		Organic Growth: New Contracts
		Organic Growth: New Users
		Growth via Mergers and Acquisitions
		The New Era of Exchange M&A
			The Merger-Driven Transformation of the NYSE
			The LSE: The Exchange That Couldn’t Say Yes
			Nasdaq and the Scandinavians
			The CME and the CBOT
		The Future
Implications of the Four Basic Transformations
	Implications of the Four Basic Transformations
		A New Wave of Product Innovation
			Innovation Acceleration in Futures Products
			The Old World: Launching New Products on Trading Floors
			The New World: Launching New Products on Electronic Exchanges
			Some Things Haven’t Changed
			Regulatory Change Drives Product Innovation
			The Rest of the World
			A Note on Innovations in Equities
Building Modular Exchanges via Partnerships and Outsourcing
	Building Modular Exchanges via Partnerships and Outsourcing
		Modular Exchange: Building Blocks
		CBOT: Cautious Migration by Outsourcing Technology
		Partnership with Eurex: First Alliance
		Partnership with LIFFE
		The Final Move
		The Rise and Fall of Eurex Us: Outsourcing Technology and Services
		Battle in the Energy Markets
		NYMEX: Outsourcing New Product Listing
		Leasing Technology
		Early Pioneers: Technology Providers
		Collaboration: Blurring the Lines between Exchanges
		Leasing Clearing Services
		CME and LNET
		The Modern Modular Exchange
Regulators: Leadership and Reaction
	Regulators: Leadership and Reaction
		The Electronic Driver and Overall Regulatory Design
		Screen-Based Trading and the Concept of Regulation by Principle
		Regulation and the Evolving Architecture of Markets
			Proliferation of Platforms
			Electronic Mishaps
		Private Club to Public Company
		Ownership and Governance of For-Profit, Demutualized Markets
		Globalization and the Accelerating Effect of Electronic Technology
		Global Competition and Mergers and Acquisitions48
		The Attraction of the Federal Model
		Implications of Market Conglomerates for Further Regulatory Integration
		National Interests
		A Word about Regulatory Structure and Philosophy
Electronic Exchanges and Trading: Benefits
	Electronic Exchanges and Trading: Benefits
		Globalization: Bringing the World Closer Together
			CME: Expansion through Global Marketplace and Acquisition
			LIFFE: Using Technology to Make a Comeback
		Surge in Volume
		Volume Growth around the World
		Innovative Products Increasing Growth
		Data, Data, and More Data
			One Screen: So Much Data
				Greater Oversight of Trading Activity
		Risk Management
			Direct Market Access (DMA)
			Shifting the Balance of Power
		Automated Trading: Replacing Humans
			Abundant Choices of Order Types
			New Trading Styles
			Smart Order Routing
Electronic Exchanges and Trading: Challenges
	Electronic Exchanges and Trading: Challenges
		Dependency on Each Other
		Technology Glitches
			Exchange Outages
			LIFFE and Its System Issues
			Seven-Hour Outage at LSE
				LSE Outage Impacting JSE
			CBOE: Floor-Trading Continues Amid System Issues15
		The Impact of Real-Time Data Availability
			Market Volatility
				Sell-Off due to System Issues
				Short Selling23
				Another Erroneous Trade, Another Volatile Trading Session
		Inefficiency: Out-Trades in the Electronic Trading World
			“Fat Fingers”: A $331 Million Mistake30
The Future of Financial Markets
	The Future of Financial Markets
		Exchange Consolidation
		In Response to Exchange Consolidation
		Transparency and Speed
		Partnership and Alliances
		Clearing: Next Transformation
		Global Financial Market for the Next Century
		Common Platforms
		Looking Ahead
Appendix A 
Abbreviations Used
	Appendix A Abbreviations Used
Appendix B 
Technology Terminology
	Appendix B Technology Terminology
Appendix C 
Markets Glossary
	Appendix C Markets Glossary
Document Text Contents
Page 2

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Page 168

166 The Four Basic Transformations

approve the merger. On July 22, 1994, the CFTC gave its approval, and the
merger became a reality. The deal itself made COMEX a wholly owned subsidi-
ary of NYMEX and gave COMEX members $62 million—$42 million at the
close of the deal and $20 million spread over the next four years. It should be
noted that in contrast to the mergers of the new millennium, this was not a full
merger, since each market retained its own memberships and trading rights.

The only U.S. exchange that is the result of multiple mergers involving a
number of exchanges is the New York Board of Trade (NYBOT), which in
1997 was purchased by ICE and recently renamed ICE Futures US. The final
merger to form NYBOT involved combining the New York Cotton Exchange
(NYCE) with the Coffee, Sugar, and Cocoa Exchange (CSCE) in 1998. But the
NYCE had already acquired the almost dormant New York Futures Exchange
from the NYSE in 1995. And the CSCE was itself a 1979 merger of the Coffee
and Sugar Exchange and the Cocoa exchange. The roots of these components
go back to 1870 for the NY Cotton Exchange, 1882 for the Coffee Exchange
(renamed the Coffee and Sugar Exchange in 1916), and 1925 for the NY Cocoa

From Coffee to NYBOT to ICE Futures

1870 New York Cotton Exchange founded
1882 Coffee Exchange founded
1914 Coffee Exchange adds Sugar as new product
1916 Name changed to New York Coffee and Sugar Exchange
1925 New York Cocoa Exchange founded
1979 New York Futures Exchange founded (NYSE subsidiary)
1979 NY Cocoa merges with NY Coffee and Sugar to create New York Coffee,

Sugar, & Cocoa Exchange
1985 New York Cotton Exchange creates its FINEX division to list currencies
1995 New York Cotton Exchange acquires New York Futures Exchange
1998 New York Cotton Exchange merges with New York Coffee, Sugar, &

Cocoa Exchange to create the New York Board of Trade (NYBOT)
2007 Intercontinental Exchange (ICE) buys NYBOT for $1 billion ($400 million

cash plus rest in ICE shares) and renames exchange ICE Futures US

The New Era of Exchange M&A

Beginning in the new millennium, M&A activity no longer was something that
occurred occasionally because there was a weak exchange that needed to be
acquired by a stronger exchange; it occurred out of necessity, because of the
fundamental transformation of exchanges away from floors and onto screens.

Page 169

Smaller to Larger: Through Organic Growth and M&A 167

When exchanges became electronic, economic cost curves shifted, and there
were very, very strong economies of scale to be gained from processing an
increasingly greater number of trades on an exchange. In a floor-based world,
adding new products involved incurring significant costs to earn the new rev-
enues that would accrue from increased trading. New floor space had to be
found to build the pits for the new contracts, and new bodies had to be put
into those pits to make markets and trade. In a screen-based environment, all
one needed was more server space to match orders and disseminate prices for
the new contracts.

So, exchanges that could expand trading in their existing contracts or could
add product lines (whether by launching new products or acquiring them via
an acquisition) would significantly lower their average costs per contract traded
and therefore increase their profits. Electronic exchanges left behind with a
small number of products and a small level of trading activity would experience
much higher average costs per contract traded and much poorer profits. To
survive and prosper, exchanges had to get bigger by increasing the number of
contracts traded on their electronic platforms. This need to get larger resulted
in a frantic quest to merge with other exchanges.

This significant ramping up of the economies of scale factor created by the
shift to screens drove exchanges to want to merge, but it was another trans-
formation we’ve discussed that made it easier for them to merge. That of course
was the shift from private clubs to public companies. To create a merger
between two public companies, you have to convince the shareholders that it’s
a good idea. For many public companies, a large number of shareholders hold
small ownership positions in the company, and these shareholders rarely get in
the way of a merger proposed by management and the Board. Even the large
shareholders generally view their stock as a financial asset, and they are looking
for a good return on their investment. So when a merger makes sense, share-
holders rarely get in the way. Not-for-profit member-owned exchanges are a
different animal altogether. Exchange members often have a strong emotional
view of their exchange, and their exchange membership generally represents a
much larger part of their net worth than does a stockholder’s shares in any
given company. The exchange is the place they go to work every day. They
have a bond with other exchange members, not dissimilar to the bonds shared
among classmates at the same high school or college. For exchanges in the same
city (like the CME and CBOT, or the NYMEX and COMEX), there are often
rivalries, as there would be between two football teams. So when members are
making a decision regarding whether to merge with another exchange, espe-
cially a cross-town rival, it is not a cold, steely-eyed business decision but
instead one infused with a significant degree of emotion.

In addition, though there are clear rules for managing mergers and acquisi-
tions among public companies, this is much less the case for nonprofit, member-
owned institutions. So it should have been no surprise that the merger between
the two not-for-profit exchanges, COMEX and NYMEX, took over six years

Page 335

Index 337

SEC (Securities and Exchange Commission), 72
Securities exchanges

competition in, 130–131
listing fees, 131

Seifert, Weiner, 173
Self-regulation, 242–243
Self-trading members, 45
Session trading, 43
SETS (Stock Exchange Electronic Trading

Service), 76
Settlement. See Clearing and settlement

Settlement price, 204n13
SFE (Sydney Futures Exchange), 35, 106
SGX, 233
Shanghai Stock Exchange, 71
Shenzhen Metals Exchange, 44
Short sales, 274, 297
Side-by-side arrangements, 87–88
SIMEX (Singapore International Monetary

Exchange), 23, 56, 138–142, 143t, 240
Smart order routing, 284
SOES (Small Order Execution System), 72
SOFE, 36
SOFEX (Swiss Options and Futures

Exchange), 15
SOFFEX (Swiss Options and Financial Futures

description of, 37–38
Deutsche Terminböse merger with, 41–42

South Africa, 42–43
S&P 500 futures contract, 188, 204n13, 293
SPDR, 201
Special Study of the Securities Markets, 46n1,

Specialists, 7, 187
Speculative capital, 129
Speed, 222, 308–310
Spread trading, 283
Standardization in trading, 18–20
Stenhammer, Olof, 35–36
Stock Exchange of Melbourne, 37
Stock exchanges. See also specific stock

demutualized, 105t
derivatives exchanges vs., 109
electronic trading by, 67t–71t74
in India, 101
regional, 10, 101, 131, 162
screen-based transition of, 66–76

Stock indexes, 139
Stockholder-owned exchanges

acquisition of, 107–108
demutualized exchanges and, 104
governance of, 240–245
growth of, 125
mergers and acquisitions benefits of, 103
ownership of, 240–245

Stockholm Stock Exchange, 104, 106
Stop order, 86, 94–95
Straight through processing, 322
SuperMontage, 72
SuperSoes, 72
Swaps dealers, 160
SWIFT (Society of Worldwide Interbank

Financial Telecommunications Market
Language), 20, 322

Systematic internalizer, 257n27

T + n, 9
TAIEX, 141
Taiwan Futures Exchange, 141
T-bonds, 33
Technology. See also specific technology

adoption of, 11–12
advances in, 15–20, 162
benefits of, 24
challenges associated with, 254
competition and, 144
definitions for, 321–322
electronic exchanges and, 224
European Union affected by, 14–15
financial markets affected by, 10–12
glitches in, 288–294
globalization through, 262
innovations in, 29
leasing, 217–218

birth of, 10
Internet effects on, 11–13

Telegraph, 178n6
TGE (Tokyo Grain Exchange), 43, 164
Tiered regulation, 236–238
TIFFE (Tokyo International Financial Futures

Exchange), 55
Time weighted average price, 322
TOCOM (Tokyo Commodities Exchange),

Tokyo Stock Exchange, 306
Tokyo Sugar Exchange, 164
Top pocket account, 75
Trade card, 7
Trade cycle

automation in, 16
back office, 80–81
electronic, 79–81
front office, 80
illustration of, 5f
middle office, 80
risk management in, 275–276

Trade matching
description of, 7
netting during, 8

Trade rejection, 7–8
TradElect, 76

Page 336

338 Index

algorithmic, 160, 178n2, 308
automated, 280–284, 308
basket, 282
data-based decision making in, 270–275
definition of, 2
derivatives, 9–10
electronic. See Electronic trading
equities, 9
errors in, 298–299, 302
floor-based. See Floor-based trading
historical methods of, 2
information-intensive nature of, 11
open outcry, 5–7, 100, 267
oversight of, 273–274
principles of, 2
speed of, 222, 308–310
spread, 283
styles of, 281–282

Trading floor
description of, 4, 96
launching new products on, 186–189

Trading permits, 188
Trading phase, 5
Trading pit, 6, 187
Trading platforms, 209, 235–236, 313–314
Trading screens, 82, 322. See also Screen-

based exchanges and trading
Trading Technologies, 214, 222, 271,

Trading volume

electronic technology effects on, 265–267
global growth, 267–270, 268t–269t

Transparency, 273, 287, 308–310
TSE (Toronto Stock Exchange), 74–75, 201,

251, 290

Turkish Derivatives Exchange, 270
Turquoise, 236, 307
2X S&P 500, 202

U.K. Listing Authority, 241
United States

exchange-traded funds in, 201
futures contracts in, 191t, 196f, 198–199
Futures Exchanges, 148, 214
member-owned exchanges in, 108–109

Universal stock ticker, 178n6

Vilnius Stock Exchange, 71
Virtual exchanges, 228
Volatility, 287, 295–296
Volume. See Trading volume
Volume weighted average price, 322

Wagner patent, 229, 255n7
Weather contracts, 190
West Texas Intermediate, 215, 234, 247
Winnipeg Commodity Exchange, 197
Wool traders, 34–35
Work-up, 89

X Factor, 147
XML (Exchange Markup Language), 19–20,


Zagel, James, 146
Zhengzhou Commodity Exchange, 44

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