Options Forum: What Demutualizing Means

The ISE demutualized itself in May 2002, less than two years after its inception. "The structure of the original launch was basically bound by the then-current regulations surrounding exchanges," says Steven Sears, project director for the ISE.

The quickly changing landscape has allowed the Boston Stock Exchange to begin life with a complete structural separation of equity investors and trading-right holders. The Boston exchange is expected to launch in the first quarter of 2004.

To state the obvious, if an exchange does not do what is necessary to make itself an attractive and viable place to do business, the right to trade there will hold little value. So, given its diminished market share and declining seat value, it should come as no surprise that PHLX's members voted 307 to 71 in favor of the change. The PHLX expects to get approval from the Securities and Exchange Commission in the first quarter of 2004.

Of course, the next possible step for these exchanges, which none will willingly discuss, is that demutualization is a necessary precursor to creating a public trading company. Given the success of the Chicago Mercantile Exchange (CME Quote), whose share price has more than doubled since its December 2002 initial public offering, other exchanges must be salivating at the notion of raising capital and offering members liquid means for monetizing their seat holdings.

"Separating ownership rights from trading rights represents the modernization of the way exchanges do business," said Meyer "Sandy" Frucher, CEO of the PHLX, in a statement released after the vote.

The upshot of this upheaval will be significant. First, exchanges will have improved oversight, as having to answer shareholders and operating in the public domain will require more transparency. In addition, migration will continue into electronic and remote trading as exchanges look to boost efficiency and profit to satisfy shareholders, resulting in tighter spreads, faster execution and more efficient and accessible markets. All in all, it's a good thing for investors.