HOW PRICE DISCOVERY WORKS:
An IMC FINANCIAL MARKETS & SHELL MIDSTREAM PARTNERS LP Case Study

On the morning of Oct. 29, 2014, the ringing of the NYSE Bell® opened the market as usual. A few steps away on the NYSE trading floor, Designated Market Maker Billy Geier was standing at the IMC Financial Markets trading post already poring over an electronic order book as he prepared for the launch of the Shell Midstream Partners LP (SHLX) IPO. Geier entered one price point after another to gauge buy-side and sell-side interest, passing on his supply-and-demand analysis to Floor brokers in the trading crowd, including the underwriter’s lead Floor trader. Next to Geier, the underwriter’s lead trader was on the phone relaying data in real time from the floor to the underwriter for SHLX’s stock, allowing the bank to assess the best price and time to open the stock.

Upon opening, Shell Midstream Partners became the largest master limited partnership (MLP) IPO in history with $920 million raised. While the IPO was an undeniably historic moment for the company, the process through which SHLX’s shares were indicated to the market is a standard practice at NYSE. It’s a process that all NYSE-listed companies go through during their initial public offering, and it’s unique to our exchange.

The NYSE price discovery and IPO opening processes are distinguished by the unique collaboration of an NYSE DMM who provides open, transparent communication with the trading floor community and the IPO underwriter who provides invaluable input regarding the opening time and price. Let’s break down the first trades of SHLX stock to see how the process works.

SPREAD ANALYSIS: PRIORITIZING PRICE DISCOVERY OVER SPEED

The company launched its roadshow with an offering price range for SHLX of $19.00 - $21.00 per common unit, with a proposed unit offering size of 37.5 million units (MLPs issue limited partnership units instead of shares). Due to strong demand during the roadshow, the deal was oversubscribed and priced the evening of October 28 at $23.00 with an increased offering size of 40 million units (46 million with the exercise of the underwriter’s over allotment option) for a $1.06 billion IPO. In the minutes that elapsed between the 9:30 a.m. ET market open the following morning and the first trade of SHLX, DMM Geier went through a progression of several opening price indications that were designed to foster price discovery and attract contra-side interest. In coordination with input from the underwriter, Geier opened SHLX at $32.00 – a nearly 40% premium to the offering price.

The key to SHLX’s open – and the opening of all NYSE stocks for trading – is that the NYSE IPO process allows banks to have real-time input through their lead Floor traders. During this process, NYSE DMMs use an electronic order book that displays all bids and offers, and provided the ability to inject various price points to gauge the interest at each level. The underwriter, with the guidance of the DMM and their lead Floor trader, then evaluates that information to identify the best price and time to open the stock. Rather than relying on an algorithm to open SHLX at $32, the bank was able to use information provided by the NYSE DMM to evaluate the pricing around that point before determining it was the best price.

In addition to providing up-to-date information regarding the opening process to underwriters, the NYSE IPO process:

  • Provides NYSE with the ability to open multiple IPOs concurrently
  • Enables the stock to open as early in the trading day as possible, allowing for the most time to trade after the banks determine the appropriate amount of price discovery
  • Results in 37% less volatility on average compared to Nasdaq on the listing day (SHLX traded between a low of $31.50 to a high of $33.65 during its opening day)

COMMUNICATION TO THE CROWD: LISTED COMPANY, UNDERWRITERS, FLOOR BROKERS, ETC.

Throughout the opening process, DMMs are responsible for communicating accurately and efficiently with multiple parties. They provide a transparent view to both the underwriter and indications of interest to the trading crowd, enabling the underwriter to make the most informed decision on opening price, volume and time, and allowing trading desks and investing firms to evaluate their strategies with respect to the IPO; they maintain open communication with NYSE Floor Brokers; and, importantly, DMMs provide transparent communication to the newly listed company.

This open, transparent communication is essential to the stock opening efficiently. It enables the DMM to distill information so that shareholders can make buy and sell decisions regarding the stock. In the case of SHLX, Geier updated the crowd more often as the price indications narrowed and IMC’s Corporate Relations team communicated with the management team at SHLX during the price discovery process.

AFTER THE IPO: THE DMM’S RESPONSIBILITIES HAVE ONLY BEGUN

After companies go public on the NYSE, DMMs have a continuing obligation to maintain fair and orderly markets for their assigned securities. They operate both manually and electronically in effort to provide lower volatility through increased liquidity during daily opens, closes, and periods of trading imbalances or instability. And, just as they do with IPOs, DMMs (in conjunction with the NYSE MAC Desk) serve as a conduit for information between the listed company and the market. DMMs are on the NYSE trading floor throughout the day monitoring the market and passing relevant information along to listed companies when necessary.

TAKE A LOOK AT SOME OF THE THINGS DMMS DO THROUGHOUT THE DAY: