The ICE man cometh
The New York Stock Exchange, an icon for two centuries, has just been acquired by an upstart exchange and clearinghouse company carrying the cool name of ICE (for IntercontinentalExchange). The company’s founder and CEO, generally a cool customer himself, is an electronic-trading entrepreneur and visionary, Jeffrey Sprecher, 58. Starting ICE 13 years ago in Atlanta, he built it into a lean, cost-conscious company that in 2012 had $1.4 billion in revenue, a splendid $550 million in profit, and a pre-deal market value of $9.3 billion. His very tall and striking wife, Kelly Loeffler, 43, has ridden shotgun on most of this trip. She’s a part of the ICE management team, in charge of marketing, communications, and investor relations. Since Nov. 13, when Sprecher (rhymes with “trekker”) closed his improbable deal and took over NYSE and its parent, NYSE Euronext, Loeffler has picked up the same jobs in the combined company.
And oh, yes, NYSE Euronext, whose 2012 revenues were $3.7 billion and its profits a bare $350 million, is not just the New York Stock Exchange. It’s also four Euronext stock exchanges in Amsterdam, Brussels, Lisbon, and Paris that ICE plans to sell or spin off, and it is additionally a European derivatives exchange called Liffe (pronounced “life”) that Sprecher had long coveted and hopes to turn into a jewel. For the entirety of NYSE Euronext — ticker symbol: NYX — ICE paid $8.2 billion in cash and stock, about 40% above the company’s market value just before the ICE deal was announced, in late 2012. After that, as the acquisition ran regulatory hurdles, the strong 2013 stock market propelled ICE, and NYX with it, to a combined market value of almost $25 billion.
But with the opening bell rung and the celebrations ended, now comes the hard work and uncertain outcome that Sprecher knew the Big Board would pile on ICE. The problem he has comes courtesy of the Securities and Exchange Commission, which in the late 1990s and 2000s chose to encourage competition in the equities markets by liberalizing its rules as to how stocks could be bought and sold. Traders responded as capitalists do, turning the market into kind of a wild thing offering more stores and cut-rate prices. Today the New York Stock Exchange, once the default destination for anyone trading its famed stocks, is staring at about 250 competitive venues busting to do the job. Many of these sites are lower cost than the exchange, and some — bearing the sinister-sounding name of “dark pools” — actually profess to deliver better executions of trades because they operate out of the public eye, removed from the bright lights of the exchange.
Naturally, this transformation of the market has battered the exchange. According to Tabb Group, a Manhattan financial research firm, the Big Board’s market share of trading in all U.S. stocks has fallen in the past six years from almost 40% to under 23% — with no certainty that the drop has ended. Still more excruciating, that slide occurred even as NYSE was contorting itself to hang on to business by rebating a portion of its transaction fees. The rebates, to explain, are not unique to NYSE. Many of its competitors are shoveling them out as well, in a practice that equates to large-scale selective price cutting. Industrywide, the rebates are called liquidity payments. Interpreted, that means they typically compensate traders who fill a trading site’s need for big customers, particularly the kind willing to accommodate (at a congenial price, of course) institutional investors wanting to buy or sell.
Further interpreted, the rebates are kickbacks. That’s the name Sprecher gives them. He despises the rebates and wants to end their existence. But stopping them cold turkey, without NYSE’s competitors following suit, would reduce, no doubt savagely, the market share being captured by the exchange. So NYSE continues to pay out rebates whose size the exchange never precisely discloses but that appear to be in the neighborhood of $1 billion or more annually.
Sprecher has blasted the industry’s rebates in the press and simultaneously said little that’s concrete about how he proposes to fix the exchange. At an analysts’ call on Nov. 19 about ICE’s strategy post-acquisition, the company’s leadoff presentation completely ignored the exchange’s competitive state, and most analysts ducked the subject as well. But with the call about to end, Sprecher himself suddenly began talking about the exchange, saying he would “task” its troops with becoming the low-cost producer and thought it could get there.
Fine goal. But that will be a Herculean job for a venerable exchange that’s heavy in bricks and mortar and employees, some still attached to old habits. Neither will it help that Wall Street keeps reinventing the definition of “low cost.” Today some institutional investors pay only 1¢ a share on their trades, or even less (which means we’re talking tenths of a cent, commonly called mills).
What Sprecher brings to the task, even so, is a career already close to Herculean. To state the case succinctly, he bought ICE’s first exchange for $1 — yes, $1 — and is now sitting atop an ever-growing phenom. Doubting a businessman with a record like his is a risky proposition.
Sprecher got to the $1 by way of a chemical engineering education in his native Wisconsin and a successful entrepreneurial life in California, where he built and operated power plants. By 1997, Sprecher was looking for some way to both hedge the price of the fuels that his plants used and sell electricity electronically across the country. He learned about a small company in Atlanta owned by MidAmerican Energy, an Iowa utility (now owned by Berkshire Hathaway), which had lined up 63 utilities that proposed to trade electricity among themselves. But the venture — called Continental Power Exchange (CPEX) — was flailing and losing about $1 million a month, on a MidAmerican investment of about $35 million.
Phoning MidAmerican’s CFO, Alan Wells, from California one day to express interest in CPEX, Sprecher was suddenly invited to a next-morning meeting in Des Moines. Managing to get there, he gave a sort of “elevator pitch,” he says, to the MidAmerican folks. They promptly tried to hire him to run CPEX. Sprecher said no: “What I want to do is buy it.” Ultimately, he and MidAmerican agreed that he would pay $1 for CPEX and grant MidAmerican an option to buy 20% of it for an equivalent $1.
Sprecher and Wells then both went to Atlanta to tell the employees that they had a new owner and that about half of them would be losing their jobs (with severance from MidAmerican). There, at CPEX’s offices, as Sprecher sat pondering whom to keep, a tech employee named Edwin Marcial came into the room and stated a series of demands. If they weren’t met, he said, he and the company’s two other programmers were leaving.
Here’s how Sprecher remembers what came next: “The first demand,” said the programmer, “is that we don’t want to write code in the language we’re using; we want to write code in Java. The second one is that we want to stop using the database product we’ve been using and go to a product made by Oracle. And the third one is that we want to get off this hardware computer network we’ve got and move onto the Internet.”
Well, said Sprecher to the programmer, he didn’t know Java from a hot rock, had never heard of Oracle, and didn’t know what a database was. But having come out of the electric power business, he knew this thing called the Internet wouldn’t fit his network. “You’ve got to understand,” he said to the programmer. “Electric utilities — they own nuclear plants. They have security details and guys with guns. They’re not going to be logging in to some modem to run their business.” Then he stopped and said: “Look, I’ll make you a deal. You can develop the program to make it work on the Internet as long as you also make it available on the hardware network.”
Marcial stayed, becoming chief technology officer and in time gaining ICE a reputation for technological brilliance (which he is now applying at NYSE). Marcial turned out to be right, of course, about the Internet; by the time the company launched its network in 2000, the alternative — the hardware network — was shut down. He meanwhile developed, as did other top CPEX executives who went home that day still employed, a great sense of loyalty to their new boss. Says Sprecher, simply: “We grew up together.”
And that is the strange story of the beginning, as told by Sprecher, who is a nonstop raconteur. His tales include revelations that in its first three years of developing an electronic network, 1997 to 2000, CPEX basically lacked revenues. Sprecher, commuting then between Atlanta and his California power plants, personally kept the company going by writing checks for the payroll, supplementing them with stock options that were then just so much paper. When in Atlanta, he lived in a motel that charged $40 a night.
But in 2000, Sprecher made it over the hump in a remarkable way. First, there was one of those magical moments of testing an electronic network: “Wow — it’s working!” (The reader may substitute stronger expletives for “Wow.”) The progress then allowed Sprecher to come up with a far-out plan that would both fold CPEX into a newly created company called IntercontinentalExchange and distribute, for free, that company’s stock to certain powerful new shareholders. These folk, who got about 90% of the company, would in effect pay for their porridge by starting to trade energy products on the company’s new network.
The lead investors, all of which were already commodities traders, were four financial companies — Goldman Sachs, Morgan Stanley, Deutsche Bank, and Société Générale — and three huge petroleum companies — British Petroleum, Royal Dutch, and Total. A rung down on the investor list were six utilities, including Duke Energy and Southern Co.
You can think of this bunch as gradually growing very grateful. In 2005, ICE went public, at a total valuation of $1.4 billion. The 13 corporate investors sold some of their stock in the offering and disposed of other shares later. Sprecher believes that each of these establishments made $100 million to $600 million on their stock — and remember, they got it free.
In the meantime, ICE’s newly public stock allowed MidAmerican to recoup its $35 million and then some, says Sprecher. The CPEX executives who had received stock options suddenly found them valuable. And Sprecher? Well, he didn’t exactly do what founders are supposed to do: end up with large ownership in their creations. He originally got only about 5% of ICE’s stock and recently, after the NYX merger, owned just over 1% of the combined company. But considering ICE’s recent market value, that stake was worth around $270 million — so we will not feel sorry for him.
Moreover, how many executives who once slept regularly in a $40 motel room have bought the highest-priced house ever sold in their city? Sprecher and his wife, Loeffler, did that. Marrying in 2004 after she had become an ICE employee in 2002, they lived for years in a midtown Atlanta condo with only one bathroom. Finally bent on his-and-hers, they succumbed to overkill. The house they bought for $10.5 million in 2009 has eight bathrooms and two half-bathrooms in 14,908 square feet.
It’s in Buckhead, Atlanta’s most exclusive area (which also happens to be near ICE’s offices, located in a high-rise on top of a leafy hill). Sprecher, who says the house was on the market “forever,” thinks of it as “kind of Santa Barbara-like Italianate.” That fits with the identity of its builders and previous residents, Jerome and Bridget Dobson, who produced and wrote the now bygone soap opera Santa Barbara. Sprecher says he and his wife mainly inhabit one area of the house. But they also use the house as an “event space” for fundraisers.
Sprecher’s ICE meanwhile has grown to be a construct with enough rooms to rival those of his house — although in contrast to the mansion’s custom appointments, Sprecher has stuck to commodities in business. Sprecher started buying futures exchanges in 2001, just a year after ICE was created, and ultimately he accumulated their business cousins, like clearinghouses. The company’s website lists six futures exchanges, 10 cash exchanges (headed now by NYSE), three over-the-counter markets (like Creditex, which trades credit default swaps), and five clearinghouses. The company’s trading operations are about 95% electronic and thoroughly global, with close to half of revenues coming from outside the U.S.
Sprecher says that both the Internet’s growth and the globalization of commodities trading were timely for ICE. “We were kind of in the right place at the right time,” he says. “And we were like a sailboat that just set the sail and was pushed along by the winds.” He acknowledges, though, that he and his team saw the trends early.
The antiquated practices of commodities exchanges helped him as well. When ICE bought New York’s Board of Trade in 2007, it was trading a contract called World Sugar that, just as the name indicated, was setting the price for sugar everywhere. But the contract was trading 4½ hours a day in Manhattan. Says Sprecher: “It really didn’t take a lot to see that the biggest consumer of sugar is China and that we were only open when it was in deep sleep. So some of what I’ve been doing is unlocking the obvious.” Today the old Board of Trade is a part of ICE Futures, and trades World Sugar 24/7.
Larry Tabb, CEO of Tabb Group, recalls initially becoming aware of Sprecher when ICE started expanding almost immediately after it was formed, buying London’s International Petroleum Exchange in 2001. “I thought he was crazy,” said Tabb, believing Sprecher would be outgunned by older, established exchanges. But within a short time, the exchange was thriving. “By God, he did it!” says Tabb. In 2005, meanwhile, the exchange — with Sprecher pressing to make this happen — stopped harboring “open-outcry” traders (the traditional, clamorous way to do futures) and became totally electronic.
Tabb sees Sprecher as highly creative, possessed of a ton of energy, and an impressive leader. Tabb is joined in that praise by Lloyd’s of London CEO Richard Ward, who was CEO of IPE when ICE bought it and worked with Sprecher in pulling off the transformation.
It is tempting to see Sprecher’s IPE success as an analog to what might be accomplished today at the New York Stock Exchange. Larry Tabb could even be cast again as a skeptic: Neither he nor Ward can envision Sprecher’s turning NYSE into a truly competitive player, not in an equities market so totally transformed. Tabb’s guess is that Sprecher will eventually spin off the exchange. Both Tabb and Ward, like many other people, think Sprecher bought NYSE Euronext principally to get Liffe.
To Ward, NYSE is “a business model that is busted.” There are just too many competing platforms you can trade equities on, Ward says, finding the whole scene “a bit of a mug’s game.” That’s British for something foolish.
You wouldn’t guess it was foolish from all of those 250 venues or so trying to do it. These start, of course, with NYSE and Nasdaq (glitch-ridden in recent years) and 11 other “lit” exchanges, meaning their quotes and transacted prices are visible to the world. The transparency of the exchanges, while laudable, actually hurts them these days. That is, a customer’s posted bid may be “front-run” by a high-frequency trader, who will have no basic interest in owning the stock he’s pounced on but will be hoping to skim off profits from those who do want to own it. Today these traders are sometimes called algos, short for the algorithmic rules they use to identify sweet spots for trading.
Then there are the “dark pools” alluded to earlier — 44 of them trading stocks, according to a recent SEC count, and all operated by broker-dealers. The biggest is Credit Suisse’s Crossfinder, which specializes in servicing hedge funds, and Barclays LX pool ranks second. Opposites of the exchanges in their transparency, and preferred by some customers who wish to keep their trading moves hidden, dark pools effect their customers’ trades out of public view. They usually don’t impose access fees (which NYSE does) and are otherwise low cost for their customers.
Close relatives of the dark pools are “internalizing” brokers — maybe 200 of them — who handle trades within their own walls. They might, for example, match one customer’s order to buy 100 shares of FedEx with another customer’s sell order for 100. More often, the broker-dealer itself acts as buyer or seller. If an order is too big for a broker to deal with internally, the broker will typically send it to a dark pool to be handled there. That kind of lateral pass actually began because the brokers wished for a larger market — that is, more participants brandishing more trading dollars.
In the spread of establishments geared up to trade, the main targets of criticism these days are the dark pools, which many traditionalists in the market suspect of trading against their customers. That charge requires a look at the bifurcated costs of a trade. First, there’s a transactional cost, which the trading fraternity, as noted, has pushed down to peanuts. For proof, look at New York discount broker E*Trade Financial, whose strategy is to attract retail customers by charging them a pittance per trade: $9.99 for any number of shares. The company doesn’t actually effect the trade. Instead, it happily patronizes dark pools that do not charge access fees and that will provide it a transactional profit by effecting its trades for next to nothing, and certainly for less than $9.99. Ironically, while all this is going on, a main conference room at E*Trade’s Midtown headquarters displays a photo of NYSE’s famous quarters at Broad and Wall, with the exchange’s flag flying high. Brett Goodman, E*Trade’s head of investor relations, laughs at this visual salaam while stating the obvious: “We have no emotional connection to the New York Stock Exchange.”
The second cost of a trade, overwhelmingly more important, is the big dollars paid or received for the shares traded. On this front, critics suspect that the operators of the pools track what their customers are doing — “see their footprint,” as the terminology goes — and, again, front-run their customers in some way. In such a rigged market, for example, an investor trying gradually to buy a large block of shares would pay a higher cost than should have been the case.
The dark pools naturally deny that anyone is rigging anything. And, in fact, allegations of wrongdoing are virtually unprovable, because the trading done in the dark pools has largely eluded analysis. In 2012 the broker-dealers’ self-regulator, Financial Industry Regulatory Authority (FINRA), actually initiated a study of trading information from 15 operators of dark pools. But no findings from that study have ever been publicly disclosed. The SEC could possibly come forth with some answers. But having set the stage for today’s confusion, it has so far limited itself to issuing white papers that circle around the subject.
From his new post as top boss of the world’s biggest “lit” market, NYSE, Sprecher himself absolves some of the players in the trading markets. “I don’t hold the dark pools accountable, and I don’t hold the algos accountable,” he says, finding them a “natural reaction” to what’s going on in the trading of equities. But his whole life convinces him the equities markets are lunatic right now. “I’m an engineer by education,” he says. “I think the world has order. Markets, for example, want competition. But the market does not want 250 places to buy and sell a commodity.”
His opinion, therefore, is that the market will somehow consolidate and that the New York Stock Exchange will supply leadership in getting the job done. Just how that is going to happen Sprecher doesn’t yet specify, and obviously it’s a tall order given the anarchy in the market. But he is hoping that the drive of Washington for more transparency everywhere in the financial world will filter into the equity markets. He also regards NYSE as “a big pulpit” from which to have a voice and has every intention of using it.
He still admires the NYSE brand as well. ICE itself, though a disruptive tech company that might have seemed a natural for Nasdaq, listed on NYSE when it went public in 2005. “The New York Stock Exchange had this glow,” explains Sprecher, “this aura.”
One knowledgeable person agreeing is Jacques Aigrain, the chairman of LCH.Clearnet, a U.K. clearing company that competes vigorously with ICE. Aigrain, hauling out descriptors not often associated with NYSE today, speaks of the exchange’s “beautiful brand.” And Sprecher, says Aigrain, “is an absolutely extraordinary leader and probably the best answer that could have existed for NYSE to reestablish itself.”
In the absence of a disclosed program for bringing that about, Sprecher has telegraphed a couple of plans. Right now, the largely electronic NYSE still has people on its trading floor at the open of the market and the close (with human intervention also at the ready all day if it is needed, say, for a flash crash). Sprecher says the floor will continue to be peopled: “If there are 250 venues where trades get done and 249 are electronic and one has an open-outcry floor” — well that, he says, would allow the exchange to differentiate itself.
He has also made it clear that ICE’s lean way of operating will be emulated in New York. Already, staff departures from NYSE are making news, most conspicuously with the impending exit of Daily Show host Jon Stewart’s brother, Larry Leibowitz, who had been COO of NYSE Euronext.
Talking to Fortune earlier this year, when regulators were still months away from approving the ICE-NYSE deal, Sprecher fell into a discussion about the headcount differences between ICE and NYSE. The Atlanta company has 1,000 employees, and most, Sprecher indicated, are pushed to the limit by their responsibilities. Next Sprecher stated NYSE’s number: 3,200 employees and 800 contract employees, who he said were basically permanent staff. There was no love in his voice for the idea of contract employees.
Sprecher then summarized a large uncertainty that hangs in his mind: “The question is: Can a 1,000-person company impart its culture to a 4,000-person company?” He had his answer ready: “I know it can because that’s the only way this deal is going to work. And it has to work.” And, yes, he agrees, “It could take a while.”
It would be good to see him succeed with the exchange, if only because business has few icons to spare, and none quite like this. The NYSE has seen a lot of history since its founding in 1792 under the buttonwood tree; perhaps it will prove adaptable enough to survive in an ICE age.
Reporter associate: Marty Jones
This story is from the December 23, 2013 issue of Fortune.