On an 11 p.m. train headed to the South side of Chicago a group of veteran bond traders could not stop talking about the amazing event they just witnessed. See, they were members of the Chicago Board of Trade and had just spent four hours peppering Intercontinental Exchange Chairman and CEO Jeff Sprecher—who had recently turned the futures industry upside down by making a counteroffer to the Chicago Mercantile Exchange’s definitive agreement to buy the Chicago Board of Trade—with questions regarding his offer for the CBOT.
While the ICE counteroffer held out the hope of increasing their payday by forcing the CME to raise its bid, very few saw themselves voting for the ICE deal going into the meeting. That changed over several hours. One trader put it simply, “Yesterday, if the Merc matches the [ICE] bid it is a no-brainer, now the Merc has to pay a premium—this is a guy with vision.”
That was the impact Sprecher had on these hard-boiled Chicago traders who went into the evening suspicious of Sprecher, who they didn’t know except for rumors he was a stalking horse for the major New York banks. And Sprecher didn’t come to the event with just a superior offer for the CBOT. He announced a solution to the convoluted mess that was the CBOT exercise right privileges to the Chicago Board Options Exchange. Looking to solve the ERP issues was a sign this was not just a move to push a competitor to pay more but a serious effort. Another CBOT member said, “Is this the next Microsoft or the next AOL? I think it is the next Microsoft. Here is a guy who is a visionary.”
Comparing ICE to Microsoft may have seemed ridiculous at the time but not now. Sprecher launched ICE in 2000 and through hard work, acquisitions, riding industry and regulatory trends and perhaps some luck grew the business to the point of being a serious bidder for the most storied futures exchange in the world. Since then, ICE’s growth was only accelerated, reaching a pinnacle with its acquisition of NYSE Euronext last year.
ICE did not succeed in its bid for the CBOT but raised eyebrows with its serious and disciplined approach to the process. When Futures decided to name a person of the year there was not a lot of debate. Sprecher took ICE from a start-up energy trading platform he purchased for $1 to a global exchange conglomerate trading all asset classes with six clearinghouses.
Strangely this was not a master plan from the beginning—in fact if the growth of ICE was planned out, Sprecher’s initial investors may have had him committed instead of writing him a check—but an evolutionary process led by a person who had a unique ability to see the opportunities from changing market and regulatory dynamics. He did this by acquiring an eclectic group of exchanges, clearinghouse and technology providers. When Sprecher started ICE he was a 100% owner and he invited 13 large market making firms to participate in the company in exchange for volume and market-making commitments. That worked very well; it is a model he continues to use.
He is not upset at the one that got away, CBOT, but did point out that ICE now owns the former Board of Trade Clearing Corporation. ICE is an amazing story of growth.
Futures Magazine: You are known for making quick, necessary and sometimes painful changes when taking over an exchange. What where the biggest changes you made after closing the NYSE Euronext acquisition?
Jeff Sprecher: We decided early on that we needed to thin out the Euronext exchanges, and as soon as we closed we began that in earnest. That was a [very] big job. Reorganizing those companies with their own management and their own systems was very complicated and to do it as quickly as we did and to have the company received so well by the public markets was really rewarding. We did what we said we would do but inside it was a tremendous amount of work.
We took the five exchanges: French, Dutch, Portuguese, Belgian stock exchanges and UK-listed business and took them public. What was amazing is that there was so much demand for the stock that we sold out. We sold the entire company in the IPO so we no longer have any direct relationship with them.
It felt like it was the right thing to do for the new combined ICE and NYSE; it allows ICE and NYSE to focus on businesses that we know and understand and put the continental European businesses in the hands of a continental European management and investor base. ICE is not trying to be the biggest company, we are trying to be the best that we can be and I didn’t think we could focus on too much at one time.
FM: The genesis of that question was some difficult decisions you had to make regarding trading floors and management of past acquisitions.
JS: It went really well because what we did at the combined company is have less layers of management between me, the Chief Executive, and our most junior people. So it is a flatter organization.
FM: Are you going to close the NYSE trading floor?
FM: How do you explain the evolution of ICE from a regional energy platform to one of the largest exchange businesses in the world?
JS: It’s completely unexpected. No one is more surprised than I. It is not what I envisioned when I started the company. I started the company for a very small specific reason: Because I was trying to solve a problem and I wanted to be a customer of the exchange. I wasn’t even an employee here. I started this as a side business because I was president of another company and happy living in California. The events and the environment presented itself such that it became too interesting not to follow where the market was taking ICE, which is what we’ve done. We’ve just ridden trends and customer demands since.
FM: You told Futures in a previous interview that you started ICE just because you wanted a transparent way to trade electricity. Was the growth of ICE an evolutionary process?
JS: There have just been a number of trends that have presented themselves when we were building the company. There was the conversion of businesses from analog to digital, the growth of the Internet and the ability to take regional businesses global. And more recently there has been demand for clearing and post- trade processing infrastructure, and those are all pretty macro trends and they all happened in the 14-year history of ICE. We continue to follow those trends.
FM: You relatively quickly bought the International Petroleum Exchange (IPE), outbidding the much larger and more established New York Mercantile Exchange at the time. What did you learn?
JS: I started ICE to organize over-the-counter, non-standardized markets and I realized very quickly that those markets were highly linked to the standardized listed futures markets and that if you could put over-the-counter and futures together on one platform with one clearinghouse you would have a very powerful operation. Today that seems obvious, in 2001 it was not so obvious; but as an outsider to this industry, I looked at it and said that seems logical to me. As you know that is where the business is headed in 2014.
FM: Your bid for the CBOT was an interesting battle. While you did not win, ICE gained a lot of notoriety and appeared better positioned as a major player in the exchange space at the end of the process. What did you learn?
JS: Not only do I see it that way but the commitment I made to my board of directors was that it was going to be hard to end up with the Board of Trade but that we would be a better company for trying. Often times when you have a failed M&A transaction, the company itself becomes a target or loses its own momentum. I made a commitment to my board that we could both lose the CBOT and be a better company. We went into that transaction with exactly that in mind. It worked. Part of what we did was we just wanted to hold ourselves to a high standard and try and be transparent and the market paid attention to that. While we lost the bid we had the opportunity during that bid process to talk about and advance the interest of our company.
FM: It seemed kind of fanciful at the beginning and CME claimed they had a stronger currency but in the end they had to pay up. Do you think the financial world took ICE more seriously after this process?
JS: I do. I knew going in that if the CBOT became a battle of balance sheets we were going to lose, but as long as it was going to be a conversation of who was going to be the better owners then we could win. Ultimately it did come down to a final balance sheet move and I dropped out because I didn’t have the wherewithal to get into a bidding war. The way we left the process was well received. My shareholders appreciated that discipline. I guess what I didn’t appreciate at the time was the strong Chicago ties between the two organizations even though they were crosstown rivals.
FM: ICE owns six clearinghouses. How important is owning the clearing process in the exchange space?
JS: It has been really important. While there is a lot of talk about whether or not exchanges should operate a vertical model, the reality is by owning trading venues and clearing venues and post- trade venues, we are able to very quickly launch new products and respond to customer demand and make changes because we can influence the entire value chain quickly and that is what you need. When I bought the IPE it had four contracts. Today that exchange has close to 1,000. [What] we have been able to do there came about once we were able to control the clearing infrastructure. Exchanges owning clearinghouses has worked for the benefit of customers.
FM: A few years back there was a regulatory push to turn clearinghouses into utilities. Is that still a threat?
JS: It would be a mistake for regulators, particularly right now, because it is very clear that as more business comes into clearing and as regulatory mandates kick in to force more business into clearing, the clearing infrastructure is going to need more capital. [With] banks being stressed by Basel rules that capital is going to have to come from clearinghouse owners and end-user market participants. You need to keep the incentives in place for all of those constituents to get value in order to attract capital. If you turn these businesses into utilities the next question you have to ask is who is going to capitalize them and why would they do that?
FM: A year ago you encouraged the end of payment for order flow, noting that you didn’t care if you lost market share, especially if it was not profitable. Have you ended this practice? Where are you in this process?
JS: We have not ended it ourselves because we cannot unilaterally end it without putting the [NYSE] at risk, but I believe it is a bad practice. I believe it is a bad practice in the futures industry as well, and there are others in the futures industry that are importing that practice (referring to CME Group’s offering three free executions in its WTI contract when someone trades one of its Brent contracts). I don’t like it because it creates incentives for intermediaries to watch out for their own interests and not the interests of their clients. Exchanges have an obligation to really watch out for and protect the true end-user. We are a self-regulated organization and that is a higher standard and means we have to put the interests of third parties oftentimes ahead of our own. I wish the regulators would step in and help us as an industry end that practice. It misaligns incentives and misaligned incentives can lead to abuse.
FM: A year ago you indicated that you could do this unilaterally. Do you now think it has to be regulatory or a mutual laying down of arms to do this?
JS: The problem with the way the industry has evolved is that in many markets the decision on where to send a trade is programmed into a smart order router. It is an algorithmic decision, not a human decision on where to send an order. Many of those algorithms have in them the notion that it should benefit the intermediary through receiving payment as opposed to benefiting the end-user who entered the order. I view that as the real issue. That’s why we need regulatory help.
FM: In a recent earnings call you discussed the problems of fragmentation and noted that you capture 2¢ on every trade, whether it is for 100 shares for an institution paying $1 in commission or a retail trader paying $10, which raises the question, why are there 54 venues?
JS: Regulators wanted to create competition and in doing so made the barriers to entry very low. And the rules require that if there is a new entrant that everybody must use them. Not only did they lower the barrier to entry but they demanded the industry use the services of the new entrant. It is great that somebody entered the market but you and I as consumers tend to have free choice, but in the U.S. equities world it is a virtual requirement that you can’t ignore any new entrant. That leads to lots of new entrants. The NYSE is running five separate exchanges underneath it. And the other big equity exchanges have multiple exchanges underneath them and there is no end in sight. Each of the new exchanges participate in the revenues of data sales. End-users tend to look for other counterparties; buyers looking for sellers and sellers for buyers. [There] is a natural formation around that of a smaller number of highly liquid venues and regulation is preventing that.
FM: When you say participate in data fees, is that the SIP (Securities Information Processor) revenues?
JS: Yes. And the SIP revenues are shared [based] on bids and offers, you don’t have to have trades. Under that scenario you created a venue to help yourself to revenues that is almost forced on the market.
FM: You advocated for the end of maker-taker. Do you expect that to happen? When?
JS: I do expect it to happen because it is a practice that is not helpful to the market and as more attention is [paid] to how this market works and what the unintended consequences are, there will be more calls for the market to change.
FM: Are your exchanges offering maker-taker prices?
JS: Yes. In the equities world almost all of them.
FM: Exchange operators have multiple exchanges with different structures aimed at different constituents. Is this good?
JS: Some pay the maker, some pay the taker. We have a market structure now where there is an incentive for a broker to take a customer order and shop it to the exchange that will give the broker the biggest rebate on one side of the trade and shop the other side of a trade on a different venue so they get paid. The incentive is not necessarily there for the broker to get the best price for his customer. It is a disservice to brokers that we as exchanges put them in that position.
FM: Would a first-in/first-out structure with one base fee be better?
JS: It doesn’t have to be one size fits all. There is room for true innovation in trying to match buyers and sellers and if we could get to that—much like in the futures industry—you would see a smaller number of venues that are trying to do different things to benefit the end-users and policing their markets to benefit the end-users. In futures we take it for granted that exchanges are able to put limits on the type of algorithms that are attached to it; we are willing to reject trades, we are willing to break trades that we think are outside the limits and have a role in the market to facilitate true price discovery. It is really hard in the equity market to do that. You [have more than] 50 venues, nobody can see a big part of the market, you can’t really reject something because it just goes somewhere else. In many ways the futures industry is the example that the equities business should aspire to. Price discovery in regulated futures markets is very good and inspires a lot of market confidence.
FM: You mentioned eliminating certain order types. Which ones have you eliminated and how will it improve markets? Is there a risk to market share?
JS: There is a risk because we are eliminating order types that many of our competitors have, so by default sending business to them. We are reducing order types that are overly complicated, that we don’t fully understand how they relate to a broader system of 50 exchanges and whether they have unintended consequences; better to eliminate them. All of our exchanges had different combinations of order types so we are making every exchange have identical order types and we will continue to review all of our order types with the eye to reducing them. There are order types that benefit one party to the trade more than the other party to the trade and I don’t think that is fair. Exchanges should have very clear standards for how the buyer and seller are going to relate to each other and get out of the way of benefiting one vs. the other.
FM: And by benefiting one side vs. the other you further bifurcate the market.
JS: Exactly. If you look at today’s U.S. equity market structure, the average trade size is about 200 shares of stock. There is very little difference on a single trade whether you have a retail investor or a large institution at this point. The smart order routers are slicing trades up into tiny little increments and sending them all over and it no longer makes sense to reward one party over another party when the reality is their behavior all looks the same and their money is all green.
FM: You have defended colocation. Is it appropriate to offer different levels of colocation with different latency levels? Isn’t that part of the problem?
JS: We had to have colocation because we had a situation before colocation where customers were trying to locate themselves close to the data centers and those with the most money were able to be the most creative at finding ways to buy real-estate [closer to the server]. By having standard colocation you lower the cost for everybody to be treated the same and take the arms race of real-estate out of the markets. That being said, not everybody needs the same speed and I don’t think you should force people to pay for something they don’t need. We are doing the best we can at trying to be fair. I appreciate what IEX is doing, which is they are trying hard to take speed out of the equation. That is a good effort. Bear in mind that they have less than 1% of market share in the United States. The market has not yet voted that they want to eliminate speed. We almost all have to do it together, which is something we should consider doing and the regulators could help us there.
FM: How would regulators do this? An overall 1-second delay?
JS: Possibly. That is basically an industry-wide speed limit that everybody would adhere to. And it would have to include dark pools and the entire industry. Another thing would be getting data so it is disseminated at the same time. I’m not sure government or anybody could pick what the proper speed would be.
FM: Do you like the new CME Group spoofing rules?
JS: Most of the major futures exchanges are taking action now to prevent bad behavior and rejecting orders that we don’t like and we are fining people for behavior that we don’t like against prescriptive standards. That kind of thing doesn’t exist in the U.S. equities markets. It is not even clear if we have the right to reject an order. The industry doesn’t have the same kind of pre-trade credit checking and rules for orderly market conduct that we have all adopted in the futures space. What CME is doing and what ICE has done along these lines are the kinds of things that the equity markets need to do. The problem is that anyone can open up a new equity exchange and the market is required to consider it in looking at best execution so there is not a way to contain behavior without regulatory help.
FM: We recently spoke with IEX founder Brad Katsuyama. He also thinks there are too many venues. Both he and the leaders of the PDQ dark pool, who put out a stock symbol for quote without a price, are on the same page as you in terms of trying to bring liquidity back into one place. What is the best way to accomplish this?
JS: What you just described is true innovation and what is [mainly] going on in the equities world is people that are just changing their pricing structure, and I don’t view pricing structure changes as being innovative. It is a requirement of you and me as a customer to go through an intermediary. As a result of that you have intermediaries who are routing for fees. An innovative matching algorithm is interesting but a smart order router is going to be asking the question, ‘what are the rebates and what are the fees?’ and that is going to determine whether or not you are going to see any of the flow. That is my complaint and it is crowding out true innovation. Maket-taker pricing/payment for order flow, the way it operates around Reg NMS, crowds out innovation.
FM: Looking at first half statistics, only 6% of ICE revenues come from cash equities trading. Do you expect this to continue? Where will growth come from?
JS: I do. The thing about that being only a small piece of our revenue is it gives us an opportunity to try some new things that NYSE did not have on its own. It is why we are eliminating order types and investing in technology inside the company because we do have some flexibility as part of a larger group. I want that percentage to go up but I am prepared in the short-term to have it go down in order to improve the market structure.
FM: ICE operates futures, equities, equity options as well as clearinghouses and OTC platforms; of all your businesses where do you see the best potential for growth?
JS: ICE moved into the interest rate business with its NYSE acquisition and it felt like a historic low in the global central bank policy. It may not have been the absolute low but it was near a low and I am hopeful the volatility that will be created as central banks go back to a [more normal] policy [will] result in a lot of risk management needs on behalf of our clients. There is this tremendous movement in the clearinghouses and there are a lot of new kinds of products and asset classes and new customers so the demand on the organization is to make sure we have the right solutions around clearing and settlement for our customers. The rules around how that is going to operate are still being developed, so it is a dynamic situation that causes us as managers to constantly be making changes and reevaluating things.
FM: You bought the predecessor to ICE for $1. ICE now has a market cap of $23.14 billion. How was this possible?
JS: We spent the whole interview talking about the capital markets and how they can be improved but the reality is the U.S. capital markets are the greatest capital markets in the world and no one is more aware of that than me. We took a modest investment and a tiny group of people and have built continuously over 14 years a great company. We’ve done that by constantly accessing these capital markets. I get paid to solve problems and create value and so I am constantly looking for problems but the reality is we are starting with the best markets in the world.
FM: What is next for ICE? Are you still looking at strategic acquisitions?
JS: I don’t know. You can legitimately understand that answer. I didn’t think we would be where we are today when we started the company. We never had a plan on where to go, we just are constantly trying to figure out where our customers need to be, and be there first. It is very complicated right now because the trends are global and a lot of them are rooted in legislation and regulation that is yet incomplete. So what you see us doing is trying to figure out where are customers are going to be and I don’t know the answer to that yet; we have a lot of simultaneous projects going on.