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February 1, 2003

A Bad Bet For Public Exchanges? Demutualization Is Not the Only Answer

By Desmond MacRae

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  • A Bad Bet For Public Exchanges? Demutualization Is Not the Only Answer

Entertaining grand dreams of becoming a for-profit stock exchange is difficult in a bear market.

So have pity on the shellshocked customers in these hard times.

Bear market or bull, the customers of these would-be profit-conscious exchanges will pay the butcher's bill: Their trading costs will go up if these misty dreams become a reality.

Experts say there is one side of stock exchange demutualization - the switch from private membership to public ownership - that is often overlooked: Making money for shareholders.

Business schools teach that companies should aim to make a profit margin of at least 15 percent to satisfy the folks holding equity ownership in a company.

That rule, applied to demutualized exchanges could, for example, force new cost pressures on Nasdaq, should it go ahead with its planned IPO. That's not a given if the bear market continues.

But these higher fees and charges, difficult to imagine amidst pre-IPO talk of raising hundreds of millions while aligning investors and management's interests, are a fact of life in the sometimes painful transition to a for-profit status.

Indeed, the Chicago Mercantile Exchange, which recently became the first U.S. market to go public, has since increased its monthly fee for live data on its successful E-mini stock indices. Fees are increasing from $10 to $15 a month, starting in April. The CME attempted to take the sting out of the increase by reducing live data fees on all its contracts from $63 to $53.

But, as exchange watchers note, stock index traders don't use Eurodollar or currency contracts. By contrast, fees for live stock quotes from the New York Stock Exchange, which itself personifies the private members only trading club, are just $1 a month.

As a public company, exchanges may have to charge customers more for faster fills and fancy new technology unless they can generate more volume, according to experts. That's because, as a public company, exchanges are serving shareholders, a restive group that will dump its stock whenever it is not in the black.

Despite the bear market and other spiraling cost concerns, demutualization is still popular. "Demutualization is pretty much a world-wide trend," said Peter Clifford, director with the World Federation of Exchanges (WFE) in Paris.

WFE is a voluntary group that represents the interests of 56 exchanges. The group accounts for most of the world's stock market capitalization. Of the WFE's members - which handle exchange traded funds, options, bonds and listed investment funds - only 18 percent are still exclusively member-owned structures. Several of these are even in the process of demutualizing.

Cohesive Strategy

Exchanges, bitten by the demutualization bug, are taking strides to distinguish more clearly between the exchanges' owners and customers, hoping to find a cohesive management strategy.

Some 70 percent of "seats" in the U.S. are owned by speculators, notes Meyer "Sandy" Frucher, chairman of the Philadelphia Stock Exchange. These business people lease seats for the income. This is similar to the way a property owner rents an apartment for profit.

These Philly speculators are not interested in brokering or trading stocks. Not surprisingly, Philly has announced it plans to join the shareholder-owned for-profit model.