Deutsche Börse lands in US via ISE

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Eurex has not sat idly by and watched US rivals steal its number one slot among global derivatives exchanges.

With the Chicago Mercantile Exchange and Intercontinental Exchange still vying for control of the Chicago Board of Trade, Eurex – a joint venture between Deutsche Börse and Switzerland’s SWX exchange – yesterday sneaked through an acquisition of its own.

The deal to buy the International Securities Exchange moves the German-controlled group into the fast-growing realm of US options, after an unsuccessful foray into US futures.

A 70 per cent stake in Eurex US was sold off to Man Financial, the UK futures broker, last year, after the unit had tried, and failed, to break the US futures market off its own bat.

The ISE deal was a surprise to investors on Monday, who sent ISE stock up 45 per cent but a logical consummation of a long-standing relationship with Eurex – the two had come close to a deal five years ago.

It marks the culmination of a US expansion effort for Eurex that goes back to the start of the decade.

Among the biggest stumbling blocks for Eurex – and its rival, Euronext Liffe which made a similar foray into the US at the same time – was that futures products in the US are not “fungible”.

That is, each exchange clears its own contracts; and a contract cannot be opened on one exchange and closed on another.

In effect, neither European exchange could ever attract the liquidity it needed to launch a credible competitive threat.

But the US options market is a different animal. Options are regulated, like equities, by the Securities and Exchange Commission, which is committed to promoting competition in order to cut costs for consumers.

In the US, options trading is fungible, with all exchanges clearing through the user-owned Options Clearing Corporation.

The ISE itself is a creature designed to shake up what once was a cosy options market. It was the first to offer electronic dealing.

Moreover, it was a trailblazer that burst the historic business model in which the various options exchanges agreed which contracts they would list, each agreeing not to offer competing products.

Within a few years, its competitors moved to electronic trading as well. But in the meantime, spreads on options tightened, cutting costs and bringing increasing liquidity to the market overall.

Options trading is the fastest growing securities segment in the US market. Overall, volumes are up 22 per cent for the first quarter of 2007.

Indeed, both the NYSE and Nasdaq have announced plans to open their own options platforms, increasing the competition.

However, analysts note that the recent acquisition by NYSE of Paris-based Euronext and its London-based futures subsidiary, Liffe, may be behind the Börse’s move.

NYSE itself has been rumoured as a possible bidder for the ISE, although it has said it is not eager for any further acquisitions right now. However, with its acquisition, the Börse is entering what analysts believe is the most fiercely contested business operated by US exchanges today.

That view has led several analysts to question the price being paid, a 47 per cent premium to where the ISE’s shares closed at the end of last week.

“They appear to be paying a whacking great premium,” said Andrew Mitchell, analyst at Fox Pitt Kelton, who follows Deutsche Börse from London.

“The more difficult thing to gauge is whether that is justified.”

If the Börse can use the ISE platform, for instance, to launch products currently traded on its Eurex platform, it could see significant volume growth.

Moreover, analysts are concerned that profit margins may be eroded by the roll-out of “penny pricing”, a move inspired by US regulators.

Penny pricing means reducing the bid/offer spread on options contracts, which had been as wide as 5 cents or more, to a penny.

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