Nasdaq to Get Boost From New Trading Rules

The new regulations would shift more derivatives trading business in its direction.
By Trefis ,

NEW YORK (TheStreet) - Exchanges such as Nasdaq OMXI:IXIC, CME Group (CME) - Get Report, NYSE Euronext (NYX) as well as Europe's LCH.Clearnet Group Ltd. and IntercontinentalExchange (ICE) - Get Report 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.

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 the regulation favors exchanges and forces 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% above its market price.

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 the 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. Since large Wall Street banks own many of the seats on these exchanges and control much of the volume traded on exchanges, the 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 avoided a decision on this issue earlier in the year, deferring to the CFTC and Securities and Exchange Commission (SEC). The banks argue that having ownership would ensure the financial soundness of the exchange. They also say their role should not be limited because they are the biggest users of these exchanges.

Nasdaq's Derivative Business Would Gain

In the U.S., Nasdaq offers trading in derivatives including options such as equity options, index options and currency options. It 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 the our price estimate.

The daily volume of options contract traded across all exchanges in the U.S. 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 U.S. exchanges rises 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.

See our full estimates for Nasdaq OMX

here

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This commentary comes from an independent investor or market observer as part of TheStreet guest contributor program. The views expressed are those of the author and do not necessarily represent the views of TheStreet or its management.

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