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Nasdaq's Upside if Regulators Enact New Derivatives Trading Rules
Exchanges such as Nasdaq OMX ( NDAQ ), CME Group Ltd . ( CME ), NYSE Euronext ( NYX ) as well as Europe's LCH.Clearnet Group Ltd. and IntercontinentalExchange ( ICE ) are jockeying for position as new regulations will require that derivatives trading should go through exchanges and be cleared through clearing houses. These exchanges have set up derivatives clearing houses in anticipation of this development while the banks, that currently control this market, have dragged their feet to push this issue forward.
In particular Nasdaq stands to gain from this business. We estimate that derivatives trading accounts for around 20% of its stock value though it only sees a fraction of the total derivatives market's trades. If regulation favored exchanges and forced banks trade more derivatives through an exchange, Nasdaq would be a prime beneficiary.
We have a Trefis price estimate of 26.59 for Nasdaq OMX Group , which is around 11% ahead of the market price.
Banks Still in Control of Derivatives Market
The over-the-counter derivatives (OTC) market is valued at over $580 trillion and five commercial banks hold almost 97% of all over-the-counter derivatives (OTC) market. Both Nasdaq and CME have very small share of this market and hope that new legislation might help it gain a larger foothold in the derivatives business.
Nasdaq would undoubtedly gain from this, and in an embarrassing discovery, a flier endorsing limits on clearinghouse ownership for banks was tied to Nasdaq. Large Wall Street banks own many of the seats on these exchanges and control much of the volume traded on exchanges and so Nasdaq does not want publicly appear as though it is trying to torpedo the banks' interests.
Under the preliminary proposal by the Commodity Futures Trading Commission (CFTC), banks and major swaps dealers would be limited to owning no more than 20% of derivatives clearinghouses, exchanges and trading systems, which the banks are disputing. Congress passed on making a decision on this earlier in the year and have deferred to the CFTC and Securities and Exchange Commission (SEC).The banks argue that having ownership would ensure the financial soundness of the exchange and so there role should not be limited, especially as they are the biggest users of these exchanges.
Nasdaq's Derivative Business Would Gain
In the US, Nasdaq offers trading in derivatives including options such as equity options, index options and currency options. Nasdaq charges a transaction fee of about 30 cents for each contract that is executed on its stock exchange. We estimate that Nasdaq's US derivative division accounts for almost 21% of our price estimate.
The daily volume of options contract traded across all exchanges in the US has increased from 13 million in 2008 to nearly 15 million currently and we estimate that it will reach 18 million by 2017 largely because of the shift towards electronic trading. Also the algorithmic trading by institutional investors will boost the trading volume moving forward.
However, there could be about 10% upside to our price estimate for Nasdaq if the daily volume of options contract traded in US exchanges increased to 27 million by 2017 because of the proposed bill.
Given the large volume of derivative contracts currently traded OTC, this could be conservative. In a scenario where the number of contracts traded via Nasdaq doubles our current forecast to reach 36 million by 2017, this would result in 25% upside to our price estimate for Nasdaq assuming similar economics.