OPINION
OCTOBER 30, 2009, 11:39 P.M. ET
Is the Stock Exchange Obsolete?
The CEO of the NYSE says the future of New York as a financial center will largely be determined by Washington.
By MARY ANASTASIA O'GRADY
In the late 18th century there was a buttonwood tree in lower Manhattan where brokers gathered to trade stocks. But by 1817, the tree had become obsolete as a trading hub. The traders migrated indoors and changed the name of their group to the New York Stock and Exchange Board. The exchange moved a couple of more times after that, and in 1903 the NYSE opened for business in the neoclassical masterpiece that still stands at the corner of Wall and Broad Streets.
Today a giant American flag stretches across the tall Corinthian columns of that elegant design—the very symbol of American economic freedom. Yet even as hordes of out-of-towners stroll by daily on tours of New York's financial landmarks, it sometimes seems that international finance is leaving the bricks and mortar behind.
With the advent of electronic markets, equities trading now largely happens in cyberspace. That fact raises the question of whether New York, with its high taxes and high-priced real estate, still makes sense as a financial center. Equally uncertain is whether the Big Board's legendary Wall Street address should be included in the profitable 21st century business model of the company, which is now known as NYSE-Euronext because of its acquisition of a European trading business in 2007. Is 11 Wall St. destined for the same fate as that buttonwood tree?
Recently I went to see Duncan Niederauer, the company's CEO, with these questions on my mind. Mr. Niederauer has only been at the helm of NYSE-Euronext since 2007. But he is no stranger to the equities markets, having spent 20 years in the equities division at Goldman Sachs.
The NYSE used to have a visitors gallery that allowed tourists to peer down on traders scurrying around the floor. But all that changed on Sept. 11, 2001. The exchange is no longer open to the public, and when I arrived at its doors I had to navigate a gauntlet of heavy metal barricades, stroll past a couple of machine-gun-toting guards, and clear a metal detector before I was escorted into the CEO's office. As it turns out, access for tourists is not the only thing that has changed in recent years. Things on the floor are a lot different, too.
I begin the interview with the broader question about New York as a financial center. Is it in decline?
That, the CEO tells me without hesitating, is largely up to our federal politicians.
"New York City's ability to compete is largely out of its immediate sphere of influence," he says. "A lot is going to have to do with what changes come out of Washington and what their regulatory and legislative response to the crisis is." Washington's response is "going to determine New York's ability to continue to compete in a world that we all know is in the process of a pretty transformational rebalancing."
The large German insurer Allianz recently announced that it would delist in New York. I wonder aloud if that isn't a bad sign. Mr. Niederauer is matter of fact, calling Allianz's decision "rational," and consistent with similar decisions made by other European companies.
"If you turn the clock back 20 or 30 years," he says, "it made a tremendous amount of sense for companies like Allianz to list in the United States because their local market was not deep, it was not liquid, it was not easily accessed by investors outside the immediate jurisdiction. So if those companies had multinational aspirations for either brand awareness, shareholder involvement or both, the only way to diversify the shareholder base was to list in the biggest capital market in the world, which was the United States. The NYSE won virtually every one of those listings."
Now, it's a different story. The "local market is a lot deeper, a lot more liquid, and it's much easier to invest cross-border than it was 20 years ago. All the big mutual funds here have no trouble and have plenty of flexibility in their charters to
enable them to invest in the local markets." As a result, Mr. Niederauer says, Allianz's decision makes sense. But he quickly adds two important points.First, the good news: There are nearly 70 Chinese companies now listed on the NYSE. "Those have all come in the last few years" and "for the same reasons that the Allianzes of the world came here 20 or 30 years ago." So far, the Chinese domestic market "is not developed, liquid or deep enough," which draws companies to the U.S.
The bad news, according to Mr. Niederauer, is that while Allianz had some legitimate reasons to delist, the 2002 Sarbanes-Oxley law may very well have been the nail in the coffin. The act—which increased the reporting burden on companies—is "one of the things that has made us less competitive," and "hurt the U.S. capital markets competitiveness."
How so? He says some companies "use it as a differentiator because they don't have a strong reputation and don't come from markets with solid regulatory oversight." But "I'm afraid in the case of companies like Allianz, it's a drag," because complying with Sarbanes-Oxley ends up costing companies a lot of money. It is worth noting, he adds, that though five Russian companies are listed in New York, not one has been added since 2004.
The CEO says small companies are especially suffering under Sarbanes-Oxley. When Congress passed the act, it was "meant to be fairly cost-effective for a small company with a fairly simple business model to comply."
But it hasn't turned out that way. "If we surveyed 100 small companies with market caps of less than half a billion dollars, let's say, I think they would all tell you, 'yes we know we were told it was only supposed to cost 75 or 100 thousand dollars a year to comply.' But most of them would say it costs about 10 times that. And that's an awful big burden for a small company to bear."
"Why aren't more smaller companies launching initial public offerings?" He quickly answers his own question: "The threshold is getting higher and higher because of all the costs associated with being a publicly listed company. A lot of that is the fear of what these things are going to cost, the creep of expense to comply with these various regulations." Even with Sarbanes-Oxley being relaxed a bit, Mr. Niederauer says the exchange still suffers from the perception of heavy regulation.
Listings, of course, are not NYSE-Euronext's only source of income. In the second quarter, revenues from listings accounted for only 17% of the total—about the same proportion as revenue from "market data" services. That's because Mr. Niederauer and John Thain, his predecessor, anticipated the fact that competitiveness in a global capital market would increasingly depend on deriving income from other products and places outside of the U.S.
In the same second quarter, derivatives trading amounted to 26% of revenue. That includes trading in American Stock Exchange options, which NYSE-Euronext acquired in 2008, and options traded through the exchange's electronic trading platform known as NYSE-Arca. Even more significantly, most of the derivatives income is generated at the LIFFE, an electronic trading platform with operations based in London.
All of this demonstrates that NYSE-Euronext executives have been able to read the electronic tape on the wall. But it's one thing to invest in Europe and cyberspace. It is quite another to argue that the historic venue in lower Manhattan retains its raison d'être.
The traditional NYSE model—using specialists to make markets—worked fine for decades because the Big Board had a near monopoly on U.S. equity trading. But now most trades are executed electronically and markets are open 24 hours around the globe. How can Mr. Niederauer still justify "the floor"? He argues that the New York floor offers customers something that computers are incapable of providing: "the human touch."
Though he doesn't want to "overplay the hand of the floor," he maintains that having people executing trades on high volatility days gives the NYSE-Euronext an edge. "I view it as having a real-time lever where we can apply as much human judgment in an individual situation or on an individual day as is required."
He says NYSE-Euronext's combination of cutting-edge technology and human judgment is "an invaluable combination that no one else can replicate. I can't do that without the floor." And because the NYSE-Euronext has expanded the products that can be traded there—adding options, Nasdaq stocks, derivatives, European stocks—some agency firms have actually added personnel recently and decided "to run their whole business from here."
Listening to the CEO promote his company, I begin to feel somewhat more optimistic than I did when I walked in. Maybe my all-time favorite New York institution—not counting the Cyclone roller coaster at Coney Island—can survive after all.
Then we circle back to the subject of regulation, and the dark clouds return. Mr. Niederauer says Washington is casting a shadow of uncertainty over the market. Exhibit A is the possibility that "the boardroom and corporate governance" could be "federalized." And he warns that "we don't need acts of Congress to talk to us about what board composition or decentralization should look like."
He is relieved that it appears Congress has shelved its plans to tax multinationals headquartered in the U.S. on their non-U.S. profits that are not repatriated. That, he says, would have been "a competitive disadvantage for U.S. companies," which could have had "knock-on effects in the U.S. capital markets." But he remains concerned about the "transaction tariff on all transactions in the regulated markets" that's currently being bandied about. "It would have disastrous consequences."
At bottom, Mr. Niederauer is worried about what government is doing to risk takers. "It was striking if not staggering that virtually no companies [backed by venture capital] came to market last year. I didn't want to hear that it was just because the market was bumpy and valuations weren't that good." He says that until late in the year that was not a valid excuse.
Though the initial offering "pipeline" is now stronger than it's been in two years, he worries about keeping the "virtuous circle" healthy. Remember how it's supposed to work: "the entrepreneur gets rewarded for taking personal risk, borrowing capital, taking an idea, starting a new business from scratch. That's America the last time I checked. When they get big enough, they've proved the idea works, they want to grow, they come to the equity market because it's an efficient way to raise more capital to grow and the next thing you know Microsoft starts in a recession and now employs 95,000 people around the world, 25 to 30 years later. That's America, that's what we're supposed to stand for, and if we're not careful that virtuous circle is going to go backward and it's going to be a vicious circle."
Small companies, he argues, are the key to the recovery. "They're the economic engine in this country, certainly after every recession. That's where most of the new job creation comes from. I think we're all a little nervous that if we start to convey that risk-taking is no longer okay, what impact does that have on entrepreneurial spirit and innovation?"
In 2008, the NYSE had one venture-capital backed company come to market all year. "That's not good," he says. Not good for the NYSE-Euronext, not good for New York, and not good for America.
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