Closely Watched Partnership: NYSE, Tokyo Exchange Already Tight

- Updated October 11, 2014

Before last week, reports of a brewing strategic alliance of NYSE Group and the Tokyo Stock Exchange (TSE) were repeatedly dismissed as premature. But John A. Thain and Taizo Nishimuro, the markets’ respective CEOs, made clear that cooperation between them and their organizations was well underway before they finally got together Jan. 31 for the official handshake in New York. Thain, who in his former role at Goldman Sachs Group had a close working relationship with Nishimuro dating back to 2002, said at the signing ceremony that they began talking about a formal partnership early last year and that working teams from both sides were already discussing key initiatives in such areas as technology, investor and issuer services, new-product opportunities, governance and regulation. Now that a letter of intent is in place that establishes the wide-ranging but non-exclusive alliance, “an aggressive schedule of meetings” will take these plans forward “over the next weeks and months,” Thain said.

Analysts see the NYSE agreement as the latest and most significant sign of the once isolated TSE’s global vision.

He added that this points to a “new era of cooperation” between the world’s two largest economies as well as stock exchanges, and is “a step toward building the world’s first truly global marketplace,” extending what the parent of the New York Stock Exchange is preparing to do by merging with Euronext. (Last month, NYSE also joined with Goldman Sachs, private equity firm General Atlantic and Softbank Asian Infrastructure Fund to take a combined 20 percent state in India’s National Stock Exchange.) Nishimuro said he is hopeful that the NYSE-TSE tie-up, which could lead to an eventual “capital alliance” involving at least partial ownership, will “serve as a pioneering business model for the exchange industry.” Underlining those “global” statements by the two chief executives, NYSE spokesperson Christiaan Brakman said, “This is the next major step in building the world’s first global market. NYSE is the world’s biggest market, and Tokyo is number two. We are building a new era of collaboration and cooperation.” “The alliance will involve exchanging information on things like new listed products and technology, and trading systems,” said Chad Cecere, international adviser at TSE. “It’s part of our overall strategy for extending our presence in foreign countries.” TSE has also signed memorandums of understanding with exchanges in South Korea and China, and Nishimuro is reportedly exploring an alliance with the Chicago Mercantile Exchange, centered on futures and Japanese government securities. Analysts see the NYSE agreement as the latest and most significant sign of the once isolated TSE’s global vision. “TSE has been sitting on the sidelines while a lot of interesting things have been going on globally,” said Neil Katkov, an analyst in Tokyo with Boston-based research firm Celent. “I think that TSE probably hopes to examine what NYSE is doing in terms of technology and in terms of regulations.” Thain and Nishimuro chose not to be too concrete about where their cooperation might end up. Thain said that the creation and launching of the relationship is most important at this stage, and that there is “no question” that there will be significant, shared benefits in systems and technology. He also spoke of “cross-listings” and of products such as exchange-traded funds that are accessible “on both markets or combinations of markets,” and of the possibility of sharing market-data products. “This has more potential than earlier announcements because the global environment has changed,” Katkov said. “There’s a competitive need to stay ahead of the game in the global exchange market.” Because TSE is not yet publicly owned–its plans for an IPO could stretch into 2009–NYSE cannot as readily purchase shares as it is doing in the Euronext merger and the purchase of 5 percent of India’s largest exchange. But it has added a critical link in the global trading chain and can offer strategic and technological guidance to a Japanese market that, recent events indicate, has sorely needed it. The all-electronic trading system that TSE adopted in 1999 was praised at the time as cutting-edge, but volume increases and other stresses led to repeated failures and outages between November 2005 and January 2006. Abhishek Kumar, an analyst in Singapore with research firm Financial Insights, said the problems resulted from a historical lack of investment in technology. As was its custom, the exchange did not initially look outside its borders for technical help. The problems came to a head in December 2005 when Mizuho Securities mistakenly placed a sell order for 610,000 shares of Jupiter Telecommunications Co. at 1 yen per share, rather than 1 share for 610,000 yen–an error that systems should have caught and cancelled. The brokerage was out $344 million, and Nishimuro’s predecessor as president and CEO, Takuo Tsurushima, and other exchange officials were either ousted or took pay cuts. “The really glaring thing was that [so many problems] happened in such a short period of time,” Kumar said. “The major problem was a gap in communication between the management team and the technology team.” With Nishimuro, who was previously TSE chairman, at the helm, the organization allocated $500 million to revamp the trading system and build an adequate backup system. The contract to develop the software was awarded to the incumbent vendor, computer giant Fujitsu, though Kumar pointed out that “the new management has taken steps to say, We’re going to work really closely with the IT team.'” New York’s Hybrid NYSE has been through a major transformation of its own. “Until a year ago, NYSE was predominately a manually matched market,” said Larry Tabb, founder of the research and consulting firm Tabb Group in Westborough, Mass. That was before the Big Board’s merger with the electronic exchange operator Archipelago Holdings of Chicago and the introduction of hybrid, or floor and electronic, trading. “New York has a more robust set of controls on their orders,” said Tabb, comparing NYSE with Tokyo. “There are controls that check the size of orders.” The alliance between the two exchanges is likely to add to the mounting pressure on exchanges worldwide to consolidate and improve their management practices and technology, said William Cline, until recently a senior capital markets partner at Accenture and now managing partner of Acai Solutions, a New York-based management consulting company. “It’s kind of like the game of musical chairs–you don’t want to be the last one standing,” Cline said. “Aggregation of liquidity across geographic boundaries and across asset classes is almost certainly going to be a prerequisite of success in the future.” Cline said that Regulation NMS in the U.S. and the Markets in Financial Instruments Directive in Europe, each requiring brokerages to provide and prove their delivery of best execution to clients, have brought technology to the forefront for both operational efficiency and competition with alternative trading systems. “It’s not just the execution of the merger that has to come to fruition–you have to pay attention to your home territory as well,” Cline said. He said that with so many international irons in the fire, NYSE Group should be cautious about being spread too thin. But he agreed with Thain that consolidation will leave just a few–Cline suggested four or five–large, multinational exchanges, coexisting with a smaller number of niche and national marketplaces. Even in this context, Celent’s Katkov regards TSE as more of a nationalistic, inwardly focused market. “I think its strategy is to maintain itself as a single, important market” that is “not interested in a regional merger,” he said. Tokyo is, however, interested in luring from other markets listings that the exchange has been losing over the past few years, Katkov said. “If TSE does not become world-class in terms of regulations and technology, it could start losing liquidity and losing out to other exchanges,” he said. The link with NYSE and its advanced infrastructure could help TSE build investor confidence and attract companies from abroad. “The stronger the exchange is, the better,” Katkov said. “There is a lot that TSE can learn from NYSE.”

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