Key Issues Facing the Financial Markets: Time to Re-Engage

I’m going to try to keep this short because you have been listening all morning.  Maybe we can do some Q&A afterward.  I was going to tell you a little bit about what we have been up to and our perspective on some of these broader issues.  There is clearly no shortage of things to talk about in our industry and the immediate issues that we are all grappling with, whether it’s short sales or the nature of dark pools or sponsored access or regulatory. 

There are so many things going on it’s really amazing.  I’m actually glad.  A couple of years ago we got so tired of talking about Reg. NMS.  Bob [Colby, formerly of the SEC Division of Market Regulation] and I, every panel that we were on, for three years we were talking about trade-through.  It’s good to have other issues to talk about and also be able to help foster a dialogue about these real issues sometimes in a public forum, sometimes not, and some of these do get contentious because we all do come from different backgrounds and we are all competing.  We are partners sometimes.  We are competitors sometimes and we are clients of each other sometimes.  It’s an interesting aspect of our industry.  But I think it’s the nature of the beast and it’s a very competitive and innovative industry.  But no matter what we do from a regulatory standpoint the goal is to continue to allow innovation and to encourage those things.

At NYSE Euronext we really haven’t done much in the last year.  In the first quarter alone we rolled out our Universal Trading Platform in Europe, taking our latency down to below 500 microseconds, and that is going to be rolling into the US later this year.  We rolled out an MTF for pan-European trading.  We rolled out SmartPool for block trading.  In the US we rolled out the New York Block Exchange, NYBX, which is our BIDS joint venture.  We rolled out NYSE Amex for options and completed the Amex integration.  We rolled out NYSE Liffe in the US for futures trading and migrated clearing off of the CME platform.  We are in the process of finally decommissioning SuperDot, which I am pleased to say really helps get us off of our legacy platform, putting us in a far more competitive position, not just as a market model but from a latency standpoint.  All of that happened within the first four months of the year.  It’s amazing how much our people have accomplished in that time period and, to be honest, just keeping the markets running during a very volatile period. 

The new model that we implemented toward the end of the year, coupled with all this new technology, really has revitalized the NYSE, what we call the NYSE classic model.  It removed the inherent conflict of the specialist, in the “look.”  It’s interesting to see it implemented in an electronic format, whether you call it a look or not, clearly giving rise to some concerns about information leakage, unless the proper surveillance accompanies it.  I look forward to the SEC looking at this, whether it’s dark pools or information leakage, at IOIs, IOCs.  However we choose to do those things, I think that is welcome. 

Getting back to the NYSE, the revitalization of that model has been gratifying in terms of reinventing the mix of high touch and high tech.  What does it mean to marry electronic trading with a high-touch environment for sensitive trades?  It was somewhat entertaining, if it wasn’t disconcerting, to see the Wall Street Journal article recently about the death of the trading floor.  Really, what they did was look at a very selective group of people on the floor who have been unsuccessful at reinventing their business.  I would encourage people to talk to other people on the Floor – Rosenblatt, a perfect example, at their desk out here [in the exhibitor hall] – of people who have changed their model to adapt to a world where you use the Floor, you use electronic trading, you trade all instruments all from the same place.  That actually is a great place to be, part of a trading community.

You are going to see us starting to roll out trading superbooths on the Floor, where you can actually operate a full trading desk on the Floor of the stock exchange, not sit on those stools and operate a desk from a decrepit booth that, to be honest, is a relic.  That will allow firms like Rosenblatt and many of the others that we have to continue to revitalize their business and in fact attract new business to the floor.  It’s just a different business.  The guys who are sitting there waiting for the old business to come back, it’s not coming back.  On the other hand, that doesn’t mean that the Floor is dead.  Even what it means to our model is really different.  I would encourage people to have those dialogues with people around on the Floor, to come down too.  We throw a lot of the parties down there.  There is no better place to have a party than the New York Stock Exchange trading floor.  But it’s not just a party venue.  I really encourage that; I think it’s really showing great progress.

On the listings front, there were a couple of hijackings that were highly publicized over the last year.  The truth is, our listings franchise is stronger than ever.  In fact, every IPO of a U.S. company this year that qualified for the NYSE listed with us, including Solar Winds last night, Rosetta Stone, Digital Globe.  In fact we are in many ways the technology listing exchange now.  It’s a big difference from what we used to be. 

When I look back at the last year I’m really amazed at what our people have accomplished, with the help of many of you in this room, in a very tough environment, a lot of turmoil, constant pressure to do more with less.  I was sitting at a conference of journalists yesterday where they said, “With all these new initiatives, you must really be increasing your technology head count.”  I said no, we are actually cutting out $100 million of cost savings.  They said, “How are you going to do that?”  It’s really about the same things that everybody in this room is doing: do more with less, do it smarter, really question the old order and really make it happen.  At NYSE Euronext we have chosen to react to the crisis by continuing to reinvent ourselves, to seize the opportunities that are out there and to actively participate in the public debate about a lot of these public-policy issues that are clearly front and center right now, as we saw this morning. 

We are at a critical juncture of U.S. history.  Our financial system has suffered some major setbacks over the last couple of years.  Many of the financial institutions that we have taken for granted, many of the icons, are gone, whether it’s Bear Stearns, Merrill Lynch, or others.  The disappearance of all of these iconic firms will be remembered by all of us as a seminal event in our histories and in the country’s history.  Just as importantly, how we emerge from this crisis as a financial system, as an economy, and as a country will play a large part in determining the role of the U.S. in the global landscape going forward.  We have a unique opportunity to fix some things that are and have been broken for a long time.  It would be a shame if we let fear, our partisan self interests, and politics either prevent us from taking action or result in overly burdensome and non-competitive regulation. 

Both the Bush and the Obama administrations have taken bold and unprecedented steps towards shoring up the fragile credit system and the economy in general.  It is really easy to nitpick and say, gee, this specific measure was not a good measure and they should have done this differently, and they should have changed this.  But the reality is, for the most part they are directionally right, at a time when fast action was more important than getting it perfect.  Just like we talked about on the panel, the short-sale ban, we could all argue right now, wasn’t good public policy as a long-term solution.  But we were at a time where we were in a crisis and we needed to do something quickly, and that was basically the only weapon in the arsenal.  So clearly, no one will argue that was great for market quality, but did it need to be done at that point?  We could very easily debate that. 

I think a lot of these measures, even if they haven’t been perfect, have taken hold.  The reality is that the credit market is starting to heal.  Are we out of the woods yet?  No.  Is the economy perfect yet?  No.  But we are actually headed in the right direction, even though it is not as quickly as all of us as impatient people in this industry would like to believe.  That is part of our culture and that is a good thing in a lot of ways.  The impatience that we bring every day, whether it is toward public policy or whether it is toward our businesses, is what encourages us to innovate.  That is what makes us always look for the next thing.  On the other hand, sometimes it’s our downfall because sometimes things take time.  You can’t get rich quick.  Schemes that help us get rich quick sometimes lead us down blind alleys, like people who were buying and selling houses for a living.  When you saw that on the front page of Fortune magazine, you knew that was the end of the bubble.  Just like when you saw in the Wall Street Journal in the 2000 era the mechanic who was day trading from his pit at Jiffy Lube.  You knew it was over.  Right?  It’s part of what makes us great as a country and an economy.  It also sometimes leaves us susceptible to overshoot, and to crazes and things that lead us into bubbles. 

We need to do everything we can to restore the faith in the integrity and fairness of the system, of the financial markets.  Sometimes that means taking medicine that we don’t like, such as the short-sale restriction.  In a perfect world, I think none of us would like to have it, but I think we realize there is a greater good sometimes, and we have to do the balancing act of not destroying the market, not harming this market, which is generally efficient and highly liquid and a model for the world, and the greater good. 

Transparency is the hallmark of a fair and efficient market.  That is why Treasury Secretary Geitner’s comments on the CDS market and derivatives exchange and how we get over-the-counter derivatives into exchanges and to more transparent clearing processes is welcome.  We need to finally do that.  The reality is we in the exchange industry and we in the clearing industry can build all the solutions we want but without the stick, the carrot won’t really help and no one will use it.  We have had a system live in Europe in the form of B-Clear for months now.  I can count the number of trades on that system on one hand because there is no impetus, there is no force, for people to use it.  We look forward to working with the Treasury and the Fed and all the other regulatory agencies in finding a way to make a solution that works for the industry but also works for the greater good.

Closer to home in the U.S. equities market, our market structure has gone astray.  Over the past 15 years the order-handing rules, decimalization, Reg. NMS were all designed to increase transparency, level the playing field and encourage limit-order display.  We now live in a completely fragmented market, with 50 or so dark pools, 10 or so exchanges, and liquidity displayed to privileged participants.  Liquidity has been driven underground and there is a privileged club of people who get to see orders before the marketplace as a whole.  We welcome the SEC’s comments toward looking at order-handling practices, looking at ATS practices, looking at surveillance, because the truth is, we need disclosure.  We need good surveillance because when information is leaked out of the marketplace in a non-level playing field way, we need to be really careful about that. 

At the same time, we need to be sure that we don’t harm the competitiveness and the innovative nature of our market.  No one would argue that the duopoly that we had in 1998 or 1995 was better than what we have now.  So I think the question is, how do we strike the balance between heavily structured, high-barriers-to-entry monopolies and anarchy.  Because the best-execution definition can really be stretched to govern almost any practice that someone wants to justify.  I think it’s a good time, particular at this time in the market, to just revisit ATS and order-handling practices, not to say what is happening is criminal, but more just to say -- just like Reg. NMS was a chance really to look at market structure and how do we revisit all of that world -- this is a chance to look at the new world we are in, and how do we fix some of the practices, and where are the lines?  Because I don’t know that most of us know where the lines are. 

On the broader regulatory front, we need to ensure that no regulatory black holes exist, that all current and future products and participants fall under a well defined, regulatory jurisdiction.  That is really hard to do.  How do you ensure that all future products fall into the current regulatory structure?  We need some sort of superstructure whose job is constantly to be looking at industry practice and understand when something hasn’t fallen into the right box, because right now we  have a mishmash of product regulation -- futures go to the CFTC, equities go to the SEC; with industry regulation, as in the insurance industry.  An insurance company like AIG engaging in some product outside of their industry, how do we make sure that they are being regulated properly?  We need to make sure that that whole matrix is always filled out so that we don’t fall into a black hole. 

At the same time, we need to avoid vilifying participants in the financial markets, such as with the proposed bonus taxes or transaction taxes or the repeal of the 60-40 rule or other such measures that would greatly harm our financial institutions or harm our financial competitiveness.  We do need accountability and we need transparency.  Make no mistake about it.  Efforts to resist that on the part of the industry will have a bad ending.  But what we don’t need is scapegoats and overly punitive responses.  This is not the time to take a pound of flesh out of someone.  It is not a time to completely find the scapegoats of how we got here.  It’s: how do we fix this so it doesn’t happen again? 

All the while, we need to keep a global awareness of the things we do.  The rules that we implement in a global market have to be informed as to what other global regulators are doing.  If we regulate CDSs in a particular way that Europe doesn’t, all that is going to happen is the volume is going to go to those places.  If we put taxes on foreign earnings of a company that is global but doing some operations out of the U.S., eventually what they are going to do is end their incorporation in the U.S.  That is all it is going to accomplish.  We have to be really careful about regulatory and legislative overreaction, at the same time realizing that the Wild West doesn’t serve the public good either.  So we have an awful lot of work ahead of us. 

All I would say to everyone in this room is, times of turmoil are times of opportunity.  I would encourage everyone to get out of your foxholes and figure out for your own careers and for your companies, how to reinvent yourself, how to reinvent your company, how to be part of the future, as opposed to sitting wondering about the past.  We at NYSE Euronext have taken that challenge very seriously.  We think that the rewards for that in this market are huge, and I would encourage everyone to look at themselves, look at their companies.  This is the time for leadership.  History will show that those who stand up in times like that, as an individual, as a company, and as a country, will be rewarded for that. 

So I want to thank everyone.  I will cut it short at that and then we can take any questions anybody might have.  In the previous panel, Bill didn’t take into account that I could have the last word.  I want to make it clear that I didn’t actually take that opportunity. 

Q:     In the panel earlier you made a comment about competition with other enterprises that might not have the same profit motive.  I wasn’t sure what you were alluding to.

LL:    It’s clear we have ATSs and ECNs and exchanges that have ownership that doesn’t necessarily need to have a profit in that entity.  We are for profit.  There is nothing necessarily wrong with that.  It’s a free world.  So when you have, for example, dealers who own exchanges, and let’s pretend they have a five percent market share in that exchange but they could get a lever into decreasing prices into the other 95 percent, there is a conflict there.  It’s not necessarily a bad thing.  It’s just something we need to be careful about, particularly when regulatory burdens are not the same in every kind of entity that we have.  It’s something that public policy needs to take a look at to make sure there is a level playing field. 

We have two directions we can go.  We can lower the bar to us, less surveillance, less strict rule making, all sorts of things like that, or we can raise the bar on the other side.  The truth is I think this is not the time to be lowering the bar.  In general we want high integrity in our markets.  We want people to have confidence in the markets.  We just need to make sure the appropriate amount of regulatory surveillance, other costs, are being borne by those entities.  Any other questions?

Q:     This is my free shot at a question to Larry.  I’m an analyst so I only get to ask him so many questions.  It just appears there is more regulatory uncertainty and extremes and more decisions to rule on now certainly since I’ve been in the industry.  I’m just trying to see, is that the way you view it?  Is it a concern of the NYSE that when you don’t even know what the regulatory structure is, all the decisions that they have to make as detailed as, say, the liquidity program?  Is that concern of the NYSE?  Couple that with, we have changing markets, we have the low-priced stocks, we have algorithmic trading.  That appears cyclical but who knows?  I guess the question is we have different market conditions in equities than we have had in a long time.  What is your view whether that is cyclical or secular?  What is your view on this regulatory uncertainty it seems like we are facing right now? 

LL:     As usual, good questions, Rich [Repetto of Sandler O’Neill + Partners].  Regulatory clarity.  I think Matt Lavicka [of Goldman Sachs] brought it up on the previous panel and he was absolutely right.  One of the things that all market participants hate more than anything else is regulatory uncertainty.  Is this Best Execution or is it not?  Where are the lines?  What ends up happening is, people who are more conservative feel they are at a competitive disadvantage to the people who are willing to stretch the rules a little bit, not even as an exchange, but I’m sure that you as broker-dealers feel the same way.  When you go to your reg people all the time and you say, why do we have to do this?  You just have a different interpretation of the same rule.  Clarity is really important. 

I agree we do have a large number of gray issues.  I think those issues have probably existed but have become more in focus than they had before probably because what ends up happening is competition will take advantage of holes in regulatory structure.  That is the nature of competition.  That is also what makes a regulator’s job so hard.  Anytime there is a vagueness or a grayness, competition will naturally drive into that hole and find some advantage there.  So we are at a unique point, whether it’s sponsored access or these dark pools or IOIs or IOCs or all of these things, or even, who is going to be my regulator tomorrow?  Those things do exist, just like when the administration was talking bout all the different things they could do to fix the economy, the economy wasn’t going anywhere because everybody was just sitting there waiting to hear what was going to happen.  So a lot of times, bad news is better than no news.  I think the regulators are aware of that.  It’s a tough job because they have so much to deal with, in addition to the politics of having to answer to Congress in addition to all those other things.  We actively engage with the regulators at every chance to try to understand what they are thinking, to make our point of view known and also at times to say we just need a decision. 

Short sales are a perfect example.  I think we all have gotten to the point of saying, we just need a decision.  Obviously nobody wants the market harmed but we need a decision so we can move on with our lives.  I think it’s our roles as businessmen to figure out how to make the most during uncertain situations.  We have to make calculated gambles.  Some of that is deciding, is this a trend or is just a blip? 

A perfect example is these low-priced stocks.  What Rich is referring to is he wrote a very good piece that focused people on, underneath the trend of volume in the U.S. market was a sub-trend that said a very high percentage of the market volume was being concentrated in a small handful of low-priced stocks, unfortunately stocks that had not been low priced for a long time.  So GM, Ford, Bank of America, GE, stocks like that that went from 50 to 2 and are hyper trading, AIG trading a billion shares in a day.  That was dominating some market trends where you would say equity volume in the U.S. has really held up.  Then you would look and if you subtracted out those stocks you realize that the underlying trend is more like down 10 percent instead of up.  It’s our job to figure out, is that a long-term trend or not?  My general thought would be the prevalence of high-frequency trading in our market means that when stocks do that, that will happen more.  That is just the nature of a high-frequency trading market.  On the other hand, we have seen an unprecedented number of broken companies recently.  You put those two together and that is why you have gotten those phenomena. 

What you are seeing is a lot of the banks in particular are recapitalizing themselves.  Many of them are either as part of repaying TARP or just general recapitalization as part of the stress tests doing secondary offerings.  Whether it was Bank of America recently or Citi doing their conversion of preferred to common, you probably are going to be seeing that followed by reverse splits and other things designed to increase their price and decrease the number of shares outstanding.  That will lessen that pressure.  I think we are going through that trend of seeing a lot of those right now.  That will always be part of that market when there is a broken stock.  We happen to have more broken stocks at the same time than usual, and I think either some of those companies are going to go out of business, as you see GM or Chrysler fighting for what they are doing to become, or they will ultimately recapitalize and get out of that hole.  I don’t know if that answers it but I think it’s a short-term phenomenon that is part of a longer-term trend but not nearly to the degree we see it today.

Q:   I’m a reporter from China.  Do you think the business model of the investment banking system on Wall Street has been changed forever since they will not have CDS products anymore and CDOs anymore?

LL:  You should be asking Rich that question.

Q:   What is their prediction of the brand new world? 

LL:  Clearly the landscape has changed.  Whether this is forever or not – forever is a long time – I think the fact that many of the major brokers are now commercial banks for regulatory purposes means the general trend is toward less leverage.  Less leverage means probably lower ROEs and things like that and these guys are going to have to change their models and figure out what is the size of the infrastructure that supports it?  You have these large banks that, look, we equities guys were, as much as we hate to admit it, basically a pimple in these big companies in most of these cases.  Fixed income was generating massive profitability.  Over the last 10 years it has really been a bull market in the fixed income and derivatives markets and that is really what has fueled the growth in a lot of these big banks.  That came to an end when they deleveraged. 

So instead of fixed income being here and equities being here and all of us equities guys grumbling, oh, they are not so smart, they just use leverage, things went more like this.  What that means though is the dollar value of their revenues has gone down significantly.  That then means that they need to figure out the factory that we were feeding with all of those revenues, whether it’s logistics, technology, management needs to be right-sized as well, and I think it is taking a while for banks to figure out, what is my business model going forward?  Without leverage, what businesses make sense to be in?  Then what is the size of my logistics base?  You are probably going to see some more mergers, but the history of merging banks together has not been great, or certainly of brokers together hasn’t been great in terms of great cost synergies and revenues walking out the door.   That is going to be the challenge for a lot of these banks looking to reinvent themselves.  Right now they are sort of in panic mode of, how do I stay alive?  They are going to get into the model of, what is my business model looking forward?  I think it will be different. 

But on the other hand, again it’s a resourceful, innovative group.  I think they will respond to that and be competitive again.  By the way there are a lot of sources of capital outside of the traditional banks now, right, between venture capital, private equity, hedge funds.  All of those things are filling some of the voids for things that were done by banks before because a lot of those things that were being done still need to be done, maybe not by the same participants. 

Is that it?  Thanks very much to everybody.  I want to thank SIFMA because these forums have really become very valuable in terms of industry debate.  It is not just a boondoggle where people come to have a party.  It really is substantive and SIFMA needs to be commended for that.  So thanks.