Mixed credit outlooks for global exchanges, says Moody’s

Moody's Investors Service expects that the global financial crisis will exert pressure on the profitability of most major equities and derivatives exchanges in 2009, according to a new report on the sector. Moody's also emphasizes that significant differences exist among its four rated exchanges (CME, LSE, NASDAQ OMX, and NYSE Euronext,) in pricing power, expense flexibility, technology, and revenue diversification — distinctions that will determine their various operating performances and deleveraging abilities throughout the financial crisis.
"Until now, the sector's revenues have held up reasonably well, and this has occurred despite — even, to a degree, thanks to — the turmoil affecting the rest of the financial sector," said the report's author, Alexander Yavorsky, "but trading volumes will likely contract in 2009, reflecting the slowdown in financial markets and the global economy." With the sector's competition showing no sign of abating, earnings will undoubtedly be squeezed, he concludes.
"Despite these common challenges," the analyst continued, "Moody's ratings and outlooks on individual exchanges incorporate significant differentiating factors, and in some cases these worsen — or in others, mitigate — the cyclical difficulties the sector faces." Of the four rated exchanges, NASDAQ OMX (Ba1) carries a positive outlook; NYSE Euronext (A1) has its rating on review for possible downgrade; and the remaining two — CME Group Inc. (Aa3) and the London Stock Exchange Group plc (Baa2) — have stable outlooks.
The report reviews the key factors that affect the strength of exchanges' credit profiles, such as their competitive positioning, in terms of market share;, pricing and technology; free cash- flow generation; and financial policies. "Also included are three stress-earnings and debt pay-down scenarios for each of the exchanges, which incorporate our sector-wide and firm-specific assumptions," Yavorsky pointed out.
In addition to their declining volumes, cash equities exchanges will also continue to feel pressure on pricing. "We expect to see continued price erosion in U.S. and European cash equities — in essence, equities pricing power will continue to be a casualty in the battle for market share," the analyst said. "Competition for market share is currently more intense in the United States than in Europe," he adds, "but as electronic trading expands in Europe, incumbents will come under major pressure."
Technological leadership has become a core differentiating factor in the industry and is likely to remain so. "In many ways, exchanges are applied technology companies that benefit from the secular growth of global financial markets," Yavorsky said.
"Technological leadership is a prerequisite for the most successful exchanges," the analyst noted, "and those that lag behind risk eroding their franchises and earnings power, or, at the very least, will have to spend the money that could otherwise be used to pay down debt."
Beyond the exchanges' ability to pay down debt through operating cash flow, management's financial policy ultimately determines what amount of cash flow leverage the exchange operates with. "Financial policy and consideration of bondholder interests are thus major components of our analytical rating approach to the exchanges," Yavorsky noted, adding that "and this approach is especially relevant in the exchanges sector, where consolidation will remain a major theme — although likely not in the very near term."
"Longer term," Yavorsky said, "we think that trading volumes will resume their growth trajectory, although growth rates are likely to moderate from pre-global recession levels." "Exchanges may also benefit from the apparent desire by regulators and the investor community for increased transparency and less systemic risk," he concluded, "which may enable them to gain market share from the over-the-counter market."