Larry Tabb is the chief executive of the Tabb Group, a financial markets research and strategic advisory firm, and TabbForum, a capital markets community Web site.
A recent editorial in The New York Times looked at the proposed acquisition of the New York Stock Exchange by the IntercontinentalExchange and that of Knight Capital by Getco. The editorial argued the following: that these acquisitions and the promotion of high-speed trading put smaller investors at risk; that the regulatory infrastructure is not sufficient to oversee the combined futures and securities exchanges; that acquisitions of this type created larger derivatives players that escalated systemic risk and posed a risk to taxpayers, and that the two acquisitions were tied to the little progress in developing comprehensive rules to stave off another financial crisis.
These ideas are misguided. Here's why:
Let's start with the Knight-Getco deal. While the private Getco is buying the public Knight, this will be a reverse merger and the merged company will be public, hence more transparent and with greater oversight by the Securities and Exchange Commission. The consolidated entity also will face the scrutiny that all public companies face - not only from the S.E.C., but from securities analysts and, most of all, investors.
Yes, it is true that electronic trading is controversial, and yes, problems stemming from electronic trading cost Knight $440 million and precipitated this takeover. Academic literature, however, has praised electronic trading for making the markets more efficient, especially for retail investors. While the efficiency created by fragmentation may make it more challenging for large asset managers to acquire blocks of stock, for individuals buying hundreds or even thousands of shares, electronic trading has made investing more democratic, transparent, faster and much less expensive.
Investors, by definition, invest â€" and traders trade. An investor holding a stock longer than a few hours is only benefited by greater trading volumes; greater volumes demonstrate increased price competition, enabling the market to validate more efficiently the price at which everyone trades. A more efficient price means a more accurate price for everyone.
Investors with short holding periods are by definition traders. Smaller traders, it is true, are disadvantaged by electronic firms. These electronic firms invest millions of dollars to ascertain the right price of every asset they trade by the millisecond. This investment generally enables investors to receive more accurate prices and pay substantially lower commissions. But it is day traders who are disadvantaged by high-speed trading â€" not intermediate or longer-term investors.
Then there is the regulatory issue. Neither the Knight-Getco merger nor an acquisition of the New York Stock Exchange by ICE will make it harder or easier for regulators to audit the markets.
Admittedly, both the S.E.C. and the Commodity Futures Trading Commission are not equipped to monitor fully the vast amount of today's trading. That said, there are outstanding proposals to develop a consolidated audit trail that will enable regulators to capture, monitor and police all securities and futures transactions more adequately.
But what about the oversight challenges posed by mixing futures and securities entities regulated by different agencies? Securities markets are regulated by the S.E.C.; the futures and commodities markets by the C.F.T.C. Both share derivatives oversight depending on the underlying product. Because they trade securities, futures and derivatives, Getco and Knight are already regulated by both agencies.
The consolidation of the se two companies will not impact oversight and may actually make it easier to oversee joint operations, because they will be consolidated under one organization and are likely to combine some of their infrastructures.
Regulatory jurisdiction has more bearing on the ICE-N.Y.S.E. acquisition. While the Big Board is primarily overseen by the S.E.C. and ICE by the C.F.T.C., in reality it is much more complex. Besides owning three equity exchanges and two options exchanges in the United States, the parent of the N.Y.S.E., NYSE-Euronext, owns equities and futures markets in Europe as well. Euronext is a composite of four equities exchanges (Paris, Brussels, Amsterdam and Lisbon) and one futures exchange. This organization is not only monitored by the four national securities regulators but by the European securities and futures regulators as well; and because it is located in London, it also is regulated by the Financial Services Authority of Britain.
ICE, besides bei ng an Atlanta-based futures exchange, owns a credit default swap clearinghouse, overseen by the Federal Reserve. It also owns ICE Futures Europe (the old International Petroleum Exchange); ICE Trust Europe (C.D.S. clearing) and other European financial assets. All these entities are heavily regulated in the United States and Europe.
Just because these firms combine does not mean that any of the myriad central banks or securities or futures regulators will give up an inch of oversight scope.
Another misconception is the idea that a combination of these firms will create larger derivatives operations that could post a threat to taxpayers because their failure could threaten the broader economy. While the acquisition of NYSE Euronext by ICE is all about derivatives, it is about transparent exchange-traded and centrally cleared derivatives â€" not the opaque, bilateral, over-the-counter transactions that interconnect global banks. The transactions that ICE and NYSE Euronext will be trading through this new entity will be like any other exchange-traded, centrally cleared product. It will be traded in the open, with pre- and post-trade market data and transactions sent to a central clearinghouse that will collect margin and manage risk.
This deal is creating exactly the kind of market infrastructure that the regulators in the United States and Europe have been trying to promote.
So while many of us in the financial markets pine for days past when people traded stocks and derivatives were something you learned (or not) in calculus class, those days are gone. Just like we remember wit h fondness the days of the '57 Corvette, the Porsche Roadster or the '69 GTO, those cars, while fun, were unsafe, noisy, uncomfortable and problematic. Technology, communications and advanced-processing techniques rendered those machines obsolete â€" just as they have done to the trading floors, practices and products of years past.
