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IntercontinentalExchange: Best in Class

IntercontinentalExchange is a standout among exchange operators that's grown along with the energy markets and now serves as a major clearinghouse for credit default swaps.
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) -- Such is the nature of securities exchanges these days that the most successful ones are those American investors are least likely to have heard of.

In part that's because the exchanges with the best prospects are in Brazil and China. One exception is Atlanta-based


(ICE) - Get Intercontinental Exchange, Inc. Report

, a nonentity at the start of the decade that has seen its


leave U.S. competitors like

NYSE Euronext



CME Group

(CME) - Get CME Group Inc. Class A Report


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Nasdaq OMX Group


in the dust since it went public in 2005.

ICE's growth mirrors that of energy markets. Ten years ago, giant energy trading companies, including banks like

Goldman Sachs

(GS) - Get Goldman Sachs Group, Inc. Report


Morgan Stanley

(MS) - Get Morgan Stanley Report

, and oil supermajors including


(BP) - Get BP Plc Report


Royal Dutch Shell


were looking for an electronic energy trading platform to compete with Enron. After other start-ups and a potential alliance with the New York Mercantile Exchange proved unworkable, the companies settled upon ICE and its garrulous chairman and chief executive, Jeffrey Sprecher (pictured above).

Sprecher studied chemical engineering in college, but spent some 17 years building power plants around the country for a California-based company called Western Power Group.

"We were not all that different from shopping mall developers," is how he describes it.

Early in that career, Sprecher met junk bond pioneer Michael Milken in connection with the financing plans for the power plant construction operation.

"I was in my early twenties and I was hoping to buy a $96,000 condominium. I wasn't able to qualify for a loan but Wall Street lent me 50 million dollars on a business idea. It was amazing. As an engineer I became very intrigued with finance and how it is in life you can borrow big amounts of money for big ideas."

When California legislators set to work to create an energy exchange in the 1990s, Sprecher denounced their plan, which he argued was skewed to protect incumbents and disadvantage smaller operators like him. He hatched his own plan to trade electricity, trying to team up with a Swedish exchange called


, now part of the Nasdaq OMX Group.

California legislators wanted to work with OM but leave Sprecher out of the equation. He allowed OM to run the California exchange in return for the Swedish firm introducing him to a small Atlanta business he bought from

MidAmerican Energy

in 2000. That became the foundation for InterContinentalExchange, which has outlived the California exchange and now trades California electricity contracts.

The key the ICE's success has been identifying new trading products and tailoring them for use by market participants.

Sandler O'Neill analyst Richard Repetto credits Sprecher with "masterful thinking," in identifying the importance of clearing trades -- a process that involves standing between the two parties involved to be sure that each party to the trade puts up the necessary collateral. Many people, including regulators, believe an important step in preventing a repeat of the 2008 crisis is making sure trades of credit default swaps and other unregulated or loosely regulated products pass through a central clearing operation. It's expected that mortgage giants

Fannie Mae



Freddie Mac



begin using a clearinghouse

to trade interest-rate swaps sometime this year.

Another important strategic move for ICE, according to Rosenblatt Securities analyst Justin Schack, was taking the license to trade futures on Russell indices from CME Group, which provided it with solid growth in a new product category last year. By contrast, CME has struggled as an extended period of near-zero short-term interest rates has tamped demand for its Eurodollar and Treasury futures, which allow traders to hedge against interest rate volatility.

"ICE has been the rare exchange company to generate meaningful organic growth in the past year or two," Schack says.

Though ICE has a reputation as Wall Street's exchange, it is hard to support the claim made by some industry gadflies, such as Sean Cota, a Vermont home heating products provider and executive at the Petroleum Marketers Association of America, that it is a tool of the investment banks. One Wall Street executive says that while Morgan Stanley and Goldman essentially put ICE in business, investment banks quickly moved to sell off their interests in order to allow the exchange to attract a wide pool of participants. Among the major dealers, only Morgan Stanley is a top-ten shareholder today, and it is number 10. ICE's board includes no Wall Street executives.

Still, Wall Street's decision to use ICE for its credit default swaps trades has given the exchange a big head start in that market. ICE's clearing unit had cleared $4.3 trillion in swaps through March 5 versus $190 million for its nearest competitor, CME Group, according to


. Credit default swaps are just one part of the global $600 trillion swaps market, the vast majority of which is not traded on an exchange but may well be headed in that direction.

Wall Street executives clearly like working with Sprecher and ICE, and the reason they repeatedly give is his willingness to adapt to their needs, rather than forcing them to use standardized products.

In an e-mail sent through a spokesman, Goldman Sachs president Gary Cohn called Sprecher, "one of the most effective operators in the exchange space. He has built his business in a way that anticipated the developments in the industry and has also built a real partnership with investors and customers. I have no doubt that, as the landscape changes in the clearing and derivatives world, Jeff and ICE will have a key role to play."

Still regulators say they are determined not to let ICE gain an unfair advantage in the clearing space.

"The best-designed

central counterparty should be allowed to emerge, rather than just the first mover winning by default. Both buy-side and sell-side firms should be able to choose through fair competition where they can best clear their trades," says Theo Lubke, a senior bank supervisor at the Federal Reserve Bank of New York.

Sprecher thinks the fact that ICE has been around for so much less time than its major competitors gives it an edge, partly because he and his employees have the feeling of ownership that comes with helping to build a business, and partly because they are less burdened by old ways of doing things.

"It's amazing to have companies that are 150 years old that are still very highly respected firms. When you think about the fact that they went through the Great Depression, the birth of the telephone, the telegraph, the computer -- all the changes that have gone on in 150 years -- these companies have done well. But the people managing them also are dealing with brands and legacies and internal practices that have grown up over 150 years, none of which we have."


Written by Dan Freed in New York