Market infrastructure is hot again. A flurry of mergers and acquisitions were announced in 2018 involving platforms that support the trading of bonds, equities, foreign exchange and derivatives.
The deals point toward several trends that are changing how markets operate, notably the strategic value of data and analytics, and indicate where industry leaders see the greatest potential for growth.
In addition, a handful of intermediaries such as Marex Spectron and Société Générale used targeted acquisitions to bolster their geographical footprint and expand their product set. Last but far from least, Blackstone, one of the world’s leading private equity firms, led the $17 billion buyout of the financial and risk division of Thomson Reuters, creating a powerful new competitor in the data and analytics space.
Two of the most active players in the M&A trend were CME Group and Intercontinental Exchange. The two companies have similar roots in the futures industry, but the deals they did in 2018 show how much their strategies are diverging.
CME made one of the biggest acquisitions of the year, the $5.4 billion purchase of NEX Group. The deal, which was announced in March and closed in November, put the Chicagobased derivatives exchange in control of two large trading platforms in the cash markets, namely BrokerTec for fixed income securities and EBS for foreign exchange.
The deal marked a major new direction in CME’s business strategy in that it took the company outside its historic home in the derivatives markets. CME has made big acquisitions before, notably when it bought the Chicago Board of Trade and the New York Mercantile Exchange a decade ago, but it has deliberately avoided buying exchanges outside the futures industry because the economics for an exchange operator in those markets are so different.
The acquisition of NEX dramatically changes that equation. CME now operates two trading platforms without the benefit of vertical integration with its clearinghouse, at least not right away.
To put it another way, CME is making a bet that the combination of trading platforms will create enough synergies to make this deal work.
Brokertec is the largest platform for the electronic trading of Treasuries and a major force in U.S. and European repo markets. Its volume in Treasury and agency debt averaged more than $200 billion in notional value per day in December 2018, up 35% from the prior December, while U.S. and European repo volumes were $256 billion and $254 billion per day, respectively.
CME already has a dominant position in the Treasury futures market and now has the opportunity to make both markets accessible through a single interface. CME officials have not yet announced how they plan to integrate Brokertec, but the expectation is that they will be looking for ways to offer greater operational efficiencies to its customers as well as more opportunities for margin offsets across the two sets of products. These should be particularly beneficial for the automated trading firms that provide the bulk of the liquidity in both markets.
CME expects similar synergies in the FX market. According to estimates by Profit & Loss, a specialist publication covering the global FX markets, CME’s FX futures market ranks as the thirdlargest FX venue in terms of notional value traded, with $83 billion in notional value traded per day in January, compared to $87 billion per day in spot trading on EBS and $95 billion on Thomson Reuters. As with Brokertec, CME has not yet announced how it will integrate the two markets, but market participants expect the deal to bring two separate but closely related pools of liquidity together under one roof, opening up many opportunities for capital efficiencies and cross-selling.
CME is certainly not alone in this space. The spot FX market is highly fragmented and several other exchanges run competing platforms, such as Cboe Global Markets with its Hotspot platform, Euronext with FastMatch, and Deutsche Börse with 360T and GTX. But CME has a much larger footprint, with potential economics of scale and scope in both trading and clearing.
CME also expects to make significant reductions in expenses at NEX, which inherited a disparate collection of businesses after being spun out of ICAP in 2016. CME is targeting $200 million in cost savings over the next three years by centralizing functions, migrating technology platforms, and reducing headcount. But the real value of the deal is in the potential growth from the synergies from combining cash and futures, according to analysts who follow the company.
“This is one of the few deals where you can find revenue synergies,” commented Alex Kramm, senior research analyst at UBS. “Cost cutting pays for the deal, but revenue growth is what makes it exciting over the next few years.”
Analog to Digital
Although the acquisition of NEX certainly will transform CME’s position in capital markets infrastructure, the deal still keeps the company largely focused on transactional business. ICE, on the other hand, has a more complex strategy. The company did not make any blockbuster deals in 2018, but it did make two small acquisitions that fit into a longer-term strategy centered on the fixed income market and corporate bonds in particular. ICE sees that market as one of the last sectors of the capital markets that has not yet made the transition to electronic trading, and the company has methodically assembled several key components of the new market infrastructure.
“We think as we plug all that together, we’ve got this amazing suite of data, analytics, trading [and] settlement services that is capturing the alpha that’s coming from the analog to digital conversion.”
In a presentation to analysts and investors in December, ICE CEO Jeffrey Sprecher explained that the company is anticipating an “analog to digital” transition in the fixed income markets. He pointed to five transactions that have given ICE the building blocks for this new business: Interactive Data Corporation, one of the largest data providers in the corporate bond market, which ICE bought for $5.2 billion in December 2015; a pair of bond pricing and valuation businesses that ICE bought from S&P Global in 2016; a fixed income index platform that ICE bought from Bank of America Merrill Lynch in 2017; and finally, two electronic trading platforms acquired in 2018—BondPoint, which ICE bought from Virtu Financial for $400 million, and TMC Bonds, formerly known as the The Muni Center, which ICE bought from its founders for $686 million.
All of these businesses contribute information to ICE Data Services, the division of the company that provides reference data, end-of-day pricing, indices and analytics as well as data from the transactions that take place on ICE’s many exchanges and trading platforms. ICE’s vision is that these data services will become far more valuable as the bond market moves into the digital age.
“We think as we plug all that together, we’ve got this amazing suite of data, analytics, trading [and] settlement services that is capturing the alpha that’s coming from the analog to digital conversion,” Sprecher said in the December presentation.
AI and Analytics
ICE’s formation of its data services division highlights one of the biggest trends in the evolution of capital markets infrastructure. The data business has gone beyond monetizing the market data that comes out of trading and clearing platforms. Market operators such as ICE have recognized the value in combining many different kinds of data and are now competing to buy more assets for their data business. In fact, some players are going to the next step, combining their data with analytics powered by machine learning and other forms of artificial intelligence.
One of the landmark deals of this type was S&P Global’s acquisition of Kensho in March 2018. S&P Global paid $550 million for the 5-year-old company, the highest price ever paid for an artificial intelligence company. Kensho uses machine learning and natural language processing to sift through documents and other forms of information to find relationships that can impact the value of a financial asset. Essentially it is a tool for quantitative analysis, and S&P decided to buy the company as a way to create a powerful new analytics engine to layer on top of the data that it already owns.
In the months since the deal, the company has integrated Kensho into its market intelligence division and has begun applying its machine learning capabilities across the company. In February, during a briefing for analysts and investors, S&P executives said that they are using Kensho’s technology in three broad areas: data ingestion, data processing and data and document delivery. One example is “entity linking,” using machine learning to link data from different sources to the right entities with virtually no errors and in far less time than it would take human beings. This not only saves time and money, they said, it also unlocks the ability to ingest datasets that are too large for traditional methods.
Doug Peterson, the company’s CEO, explained that the overall goal is to run the data business as a “factory” that treats data as a commodity that can be ingested, processed and distributed on a massive scale. It may require heavy investment in the near term to develop the new business model, but he sees it as central to the company’s future.
“Data is core to our strategy, core to our business growth, core to the commercial propositions that are being developed by our businesses,” said Peterson. “We make a lot of investments in this area, but ultimately, this will be the main driver of revenue growth for the company in the future.”
The biggest example by far of this trend was the buyout of the financial and risk division of Thomson Reuters. The deal was organized by Blackstone, one of the top firms in the private equity business, with financial backing from two other institutional investors, the Canada Pension Plan Investment Board, which manages Canada’s national pension fund, and GIC, the sovereign wealth fund established by the government of Singapore. The consortium paid Thomson Reuters about $17 billion for 55% of the business unit, known within Thomson Reuters as F&R, and set it up as a new company called Refinitiv.
“We believe that as machine learning will increasingly replace human business processes, data is going to be an extremely valuable commodity.”
In effect, Blackstone is making a bet that the data assets within that business can be monetized more effectively as a stand-alone company. In its past incarnation, the F&R business was best known for the terminals that sit on trading desks, but Blackstone executives are more interested in the potential to develop a data and analytics platform that can compete with Bloomberg, FactSet and S&P Global as well as the data division of ICE.
According to Refinitiv, its data feeds deliver up to 6.3 million updates per second for more than 65 million instruments. Its FIX order routing network handles order flow of over 40 billion shares a day, and its messaging service provides access to more than 300,000 financial professionals. It also owns one of the world’s largest entity databases covering three million corporations and operates the largest “know your customer” utility with nearly 400,000 records.
“The most valuable part of that business by far is the data part,” Tony James, the president of Blackstone, said shortly after the deal was announced in January 2018. “The terminals are the legacy business for which people think of them but that’s not where the future of that company is.”
Unlike market operators such as CME and ICE, Blackstone is not in this business for the long run. Like other private equity companies, it looks for opportunities to buy assets, turn them around, and then sell them a few years later. That strategy is exactly what played out with another capital markets infrastructure deal involving Blackstone in 2018, this time as a seller.
In 2014, Blackstone partnered with the merchant banking arm of Goldman Sachs to buy Ipreo, a company that provides a range of services related to capital-raising activities such as the issuance of stock. Blackstone and Goldman Sachs bought Ipreo for $975 million, half of which was financed through debt, and sold it four years later to IHS Markit for $1.855 billion.
Whether Blackstone can do the same with Refinitiv will depend on its ability to grow revenues. Major cost reductions are already under way, with a target of $650 million in annual cost savings by 2021, and that will go a long way to making the deal work, but Blackstone executives see the real upside in the company’s potential to profit from the convergence of cloud computing, big data and artificial intelligence.
Martin Brand, the Blackstone senior managing director who was the architect of the deal with Thomson Reuters, gave a detailed description of the strategy in an August podcast hosted by Waters Technology, a specialist publication that covers the market data sector. Brand’s thesis is that artificial intelligence needs vast amounts of data in order to reach its potential, and therefore whoever controls that data, and more importantly, knows how to organize the data so that it can be consumed by AI, will be positioned for exceptional growth.
“We believe that as machine learning will increasingly replace human business processes, data is going to be an extremely valuable commodity,” Brand said during the podcast. “But data needs to be efficiently ingested, it needs to be distributed, it needs to be classified so you can find what you’re looking for—and those are areas where F&R is a market leader.”
A secondary part of the plan is to monetize certain assets within Refinitiv that sit outside the core data business. Two of these assets are particularly relevant to the market infrastructure business: Tradeweb, a fixed income trading platform that is majorityowned by Refinitiv, and FXall, a foreign exchange trading platform. Both platforms focus on supporting dealer-to-customer trading in over-the-counter markets.
Blackstone indicated last fall that it plans to sell its stake in Tradeweb through an initial public offering, and in January the company reportedly submitted an IPO filing to the Securities and Exchange Commission. If Blackstone follows through with this plan, Tradeweb will become a publicly traded company, giving it more room to grow on its own. Many analysts have speculated, however, that Tradeweb may end up being acquired by one of its competitors, given the appetite for M&A in the market infrastructure sector.
The other big trend running through 2018’s M&A activity was consolidation among the technology vendors that support the trading of financial assets. Two deals in particular stand out: ION Group’s £1.5 billion acquisition of Fidessa, and Nasdaq’s $220 million acquisition of Cinnober.
“This combination will leverage Virtu’s financial technology— the same technology that drives our marketmaking performance—to optimize all aspects of the business, from order routing and algo performance to middle- and back-office efficiency.”
The technology vendor space has been consolidating rapidly in recent years, and Fidessa was one of the few independent companies remaining. In fact, ION had to outbid two other technology companies interested in buying the vendor—Tenemos and SS&C.
Fidessa’s strengths are in equities and listed derivatives markets, where its systems are widely used for executing trades. Its customer base has grown as banks have outsourced exchange connectivity and execution management systems to specialist technology providers. The Fidessa acquisition also allows ION to combine multiple technology components into an integrated, front-to-back system for futures brokers.
Industry analysts said the acquisition will strengthen ION’s position as a leading provider of trading technology to banks, brokers and trading firms. The company has grown through nearly a dozen acquisitions over the last decade, including several well-known trading systems for listed derivatives such as Patsystems and FFastfill. Rather than making a play for next-generation technologies such as artificial intelligence, ION focuses on cutting costs, consolidating platforms, and creating economies of scale that allow it to outcompete its smaller rivals.
The Nasdaq Cinnober deal, which was announced in September and closed in January 2019, focused on a different sector of the market. Cinnober’s core business is providing to exchanges trade matching engines, clearing systems and other types of market technology. Nasdaq has been in this business since 2007, when it acquired OMX, the Scandinavian market operator. In effect, buying Cinnober bolsters Nasdaq’s market technology business by taking out one of its main competitors and consolidating two sets of similar products and services. It also gives Nasdaq at least one important new customer. In January 2019, OCC, the world’s largest clearinghouse for equity derivatives, announced a top-to-bottom overhaul of its technology and tapped Cinnober to provide a real-time clearing system to replace its legacy platform.
Richard Repetto, a principal in the equity research division of the investment bank Sandler O’Neill, commented that the acquisition of Cinnober fits into an overall effort by Nasdaq to focus on areas of growth outside its traditional trading and clearing businesses. He pointed to several other recent deals, such as its $705 million acquisition of eVestment in 2017, and noted that the company now earns a majority of its revenues from non-transactional lines of business. “Nasdaq is focusing its resources on the higher growth segments of its business—information services and market technology,” he said.
Banks and Brokers
Amid the flurry of activity among the market operators, data companies and technology vendors, where were the intermediaries? Banks and brokers played a smaller role in the M&A landscape of 2018 but there were some notable deals.
The largest by far was Virtu Financial’s $1.1 billion acquisition of ITG. This deal did not involve any trading platforms or data services. In fact, Virtu sold a trading platform—BondPoint—earlier in the year. But it did highlight an important trend in how market participants access the markets.
Virtu originally began as a proprietary trading firm that had no customers, but over the last several years it has begun providing trading services to asset managers and other institutional clients. That transition started with Virtu’s acquisition of KCG, which itself was a merger of Getco, a proprietary trading firm, and Knight Capital, a broker dealer. Adding ITG is both a consolidation play—it adds more customers to Virtu’s existing clientele— and an extension of technology. And it highlights the growing importance of nonbank financial institutions as intermediaries between markets and customers.
“ITG has built a first-class global institutional client franchise with incredible people that will benefit from this strategic combination,” Doug Cifu, Virtu’s chief executive officer, said in November when the deal was announced. “This combination will leverage Virtu’s financial technology—the same technology that drives our market-making performance—to optimize all aspects of the business, from order routing and algo performance to middle- and back-office efficiency.”
Another deal involving intermediaries came in July, when Société Générale reached an agreement with Commerzbank to purchase its structured products business. The French bank said the move was aimed at expanding its fund management business and strengthening its footprint in Germany. The deal includes not only investment products but also sales, marketmaking and technology infrastructure.
One byproduct is that the deal will generate more demand for the French bank’s derivatives expertise and more transactional flow for its derivatives trading desks. Commerzbank created many of its structured products by bundling together options based on European and Asian stock indices. To manufacture these products, Commerzbank operated a trading desk with access to index options markets such as Eurex, Euronext, LSE and HKEX. The German bank also manufactured similar products based on commodity options for investors interested in exposure to global commodity markets.
Opportunities in Commodity Markets
A similar deal, though on a smaller scale, was Marex Spectron’s acquisition of Rosenthal Collins Group, a Chicagobased futures brokerage. Rather than buying the whole company, Marex bought most of the assets, including the customer accounts and the operational infrastructure supporting that business.
Marex Spectron sees the deal primarily as an opportunity to accelerate its growth in North America. In an interview with MarketVoice, Ian Lowitt, the company’s chief executive officer, explained that he plans to keep RCG as a separate brand and maintain its position as one of the top clearing firms for agricultural producers.
“We respect the tradition of Rosenthal Collins and we are retaining the brand, the employees, the brokers and the business model. These are two extremely complementary businesses.”
“We always had an interest in growing our presence in the U.S. clearing market, but it’s a challenge to compete against the entrenched players,” said Lowitt. “This was an opportunity to obtain a great franchise with massive strength in grains and livestock, and a customer base interested in the services we can provide.”
Marex Spectron is a member of more than 40 exchanges including the London Metal Exchange, where it is a category one member. It now has the opportunity to offer a broader set of commodity futures to customers on both sides of the Atlantic. For example, the combined company can offer its customers access to the European wheat futures contract listed on Euronext side by side with the Kansas City and CBOT wheat futures listed on CME.
“We respect the tradition of Rosenthal Collins and we are retaining the brand, the employees, the brokers and the business model,” he said. “These are two extremely complementary businesses.”
Lowitt also sees growth opportunities in a related area: creating customized hedges for agricultural clients. These structured products do not trade on exchanges; instead they are offered as a bilateral contract, but their components are derived from the futures and options that trade on commodity exchanges. This is a growing area of business for commodity-focused brokers; in fact R.J. O’Brien, the largest independent futures broker in the U.S., recently set up a new division to focus on structured products.
One other deal is worth noting in the intermediary sector. BCG, one of the largest brokers in OTC markets, bought Poten & Partners, a small firm with a valuable foothold in a rapidly growing niche of the commodity markets. Poten focuses on the shipping market, and BGC is betting that the demand for ships is about to explode due to the emergence of the U.S. as a major exporter of liquefied natural as. According to the Energy Information Administration, an arm of the U.S. government, the country’s capacity to export LNG will double in 2019 as new liquefaction plants come online, and EIA predicts that the U.S. will soon rival Australia and Qatar sources of LNG. In that new market environment, the companies moving LNG to markets in Europe and Asia will need to hedge their shipping costs through the use of freight derivatives. BGC’s deal is essentially a move to capitalize on that trend and matches up well with the company’s existing strengths in other parts of the OTC energy markets.
The M&A trend looks set to continue in 2019. At the start of the year, Nasdaq and Euronext were escalating their bids for the Oslo Stock Exchange, a sign that even traditional stock exchanges in relatively peripheral markets are attractive targets.
In addition, Cboe revealed that it halted its share repurchase program in the fourth quarter in order to reserve cash for “a potential near term strategic acquisition.” And in mid-February, Theodor Weimer, the chief executive officer of Deutsche Börse, said that his exchange is “actively screening the market for potential targets or partners.”
For many players, however, the main focus will be on integrating their acquisitions, rationalizing the cost structure, and creating new services. In one sign of this trend, ICE announced on Feb. 14 that it had the two trading platforms it bought in 2018 with ICE Credit Trade, the credit default swap platform it acquired a decade ago with the purchase of Creditex.
ICE said the three platforms will be unified in a new division under a single management team headed by Marshall Nicholson, a bond market executive with experience running both platforms and broker-dealers. ICE also said the new division, which will be called ICE Bonds, will leverage the fixed income pricing and analytics offered by ICE Data Services.
“ICE has a long and exemplary track record of using advanced technology and innovation to bring more transparency and efficiency to opaque markets,” ICE President Ben Jackson said in a statement. “As fixed income markets continue to evolve, bringing our execution platforms under a single structure and leadership team allows us to focus our efforts and provide our customers with a wide array of tools to accurately value bonds, find inventory, efficiently trade and manage risk.”