Exchanges Face a Daunting 2010

Talk of financial reform is prompting investors to flee shares of the CME Group and NYSE Euronext—despite evidence that new rules could help the exchanges

By Ben Steverman

An old Wall Street saying holds that "the market hates uncertainty."

Given the regulatory clouds hanging over the operators of financial exchanges—publicly traded outfits such as NYSE Euronext (NYX) and the CME Group (CME)—investors have come to loathe the very companies that enable the Street's day-to-day operations.

Shares of CME, the world's largest futures market, are off 19.4% since the beginning of 2010. NYSE, the owner of the largest U.S. stock exchange, has seen its stock drop 8.2%. IntercontinentalExchange (ICE), the commodities powerhouse, has lost 15% this year, while Nasdaq OMX (NDAQ), the owner of the second-largest U.S. equity exchange, is down 5.7%.

Losses deepened on Feb. 4 after a disappointing quarterly report from CME. The company's revenue fell 3.5% from a year ago, and earnings-per-share fell 6¢, or 1.7%, below analysts' estimates.

All the gloom could eventually create opportunities for patient investors, says Alan Lancz, president of Alan B. Lancz & Associates, which owns Nasdaq, CME, and NYSE shares.

For now, however, Lancz says, "I don't see a catalyst." Shares are beginning to look attractively valued, he adds, but 2010 could be tough on exchanges.

Looming Reforms

The financial crisis and fierce competition had already slashed exchanges' share prices over the past two years. In recent weeks, Washington's renewed focus on financial reform has slammed the stocks again.

"The big issue right now is uncertainty," says Larry Tabb, chief executive of the TABB Group, a research firm specializing in capital markets. Lawmakers and regulators are reviewing nearly every aspect of the way financial products are exchanged. "There are so many rules proposed by so many bodies that it's very difficult to keep track," Tabb says.

Analyst Patrick O'Shaughnessy of Raymond James (RJF) counts 12 major issues facing the industry, including proposals for a transaction tax and a ban on proprietary trading by bank holding companies.

How Exchanges Could Benefit

Executives at the CME argued Feb. 4 that new regulations could actually help exchanges. "There are few areas of potential harm to our business, and many areas that are potentially favorable for CME Group and other exchanges," CME Chief Executive Craig S. Donohue told analysts.

Among the biggest potential benefits to the industry is a drive to push more transactions onto exchanges, where complex financial products—of the sort that prompted a federal bailout of American International Group (AIG)—can be standardized and risk more easily monitored.

Yet investors say it's not possible to ignore regulatory risk when so much is happening in Washington. Keeping track of it all "would be a full time job in itself," Lancz says.

Investors have expected new financial regulations for more than a year. But the Massachusetts election of Republican Scott Brown to the U.S. Senate on Jan. 19, and subsequent tough talk about Wall Street from President Barack Obama, have raised the temperature in Washington.

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