Founded in May 2000 as the first U.S. electronic options market, the International Securities Exchange became the world's largest equity options exchange in less than three years on the strength of its innovative model and technology. Its meteoric rise transformed the industry by forcing rival exchanges to run more efficiently, ultimately boosting options trading volumes from record to record.
Gary Katz co-founded the exchange, and served as chief operating officer from the start. On Jan. 1, Mr. Katz became chief executive officer, succeeding co-founder David Krell, now chairman.
When the ISE made its debut, 726 million options contracts traded on five exchanges. Last year, 2.86 billion contracts changed hands, reflecting the impact of easy electronic access to markets and institutional investors' growing interest in options strategies.
The ISE went public in 2005 and was acquired in December 2007 by Eurex, which is partly owned by Deutsche Boerse Group AG. It was the first time a foreign market bought a U.S. exchange. The ISE broadened the scope of its business in December 2006, with the launch of the ISE Stock Exchange.
On Feb. 24, it announced plans for a joint venture with the Osaka Securities Exchange to launch a new options market in Japan, which will add even more of a global flavor.
The ISE has been credited with playing a major role in the explosion of equity options trading. Are you willing to take credit for it? What people tend to forget is that we are in economic cycles. We had a great run in both options and futures in terms of increasing volumes, even during bubble-bursting periods in the markets. There were big changes in technology and greater efficiencies. But there are periods when volume slows down and extended periods of great volatility; there is exhaustion (in terms of volume growth) at some stage. You can't control volumes. So, we have to continue to innovate and stay hungry.
Many competitors have taken the opportunity to retool and refocus their strategy to become more entrepreneurial in a competitive environment. But we're running hungry. We've always been that way. We would be in a very different place otherwise.
The ISE is always associated with technology. Did other factors help its growth? The focus for us at the beginning was to look at the entire process of trading and to bring value-added functionality to that process.
For options, we thought we could add many values to trading, such as speed of execution, efficiencies, new market entrants, new liquidity providers and a new way to access the exchange. All of this contributed to our success.
We're always thinking in terms of innovation. Look at the ISE Stock Exchange MidPoint Match (which crosses orders at the midpoint between the best bid and best offer). It's a new and innovative value-added approach that did not require any technology upgrades.
Similarly, what we are doing in Osaka is to work with a local presence the Osaka Securities Exchange, (which has) an existing relationship with regulators and customers and finding new ways of trading options in that marketplace, much the same way as on the ISE.
The planned joint venture with Osaka was announced shortly after Eurex's acquisition of the ISE. Were the two related? No. The talks were going on prior to the merger with Eurex. That was an independent initiative from the ISE. It fits into the model I'm trying to describe. It's not about doing something new, but to do it better, create value-added to grow that marketplace. Options are very small relative to equity markets in Japan. You don't have the derivatives market in single-stock options that you would expect for such a liquid underlying stock market.
Competition is heating up among execution venues. Does it affect your business strategy as the new CEO? Recognizing competition is an opportunity to do something about it, rather than crying over the facts of life.
There is more competition today than in the past, so, we look for opportunities under a new paradigm. This has not changed our focus on what we have done; we look for opportunities in a new marketplace.
Penny quoting is changing the options industry. The greatest thing I can do is to look for opportunities to leverage the ISE strengths, our system and our functionality. Our success has been our ability to adjust to the growth curve with our technology so that we could process even greater volume than anyone predicted. By doing this, we are further distancing ourselves from our competitors.
In the futures world, you can have a 100% market share. In the equities world, just a few years ago, you could have an 85% market share. ISE is the No. 1 equity options market, with a hair over a 30% market share. So, you could not describe a more competitive environment than we have today in options.
You have to look at How do we grow our business? and not be satisfied with what we have. It's like climbing an ice mountain: The moment you stop climbing, you slide very fast ...
It is part of that growth decision that we are not limited to the U.S. Osaka is an example of opportunities. There are other Osakas out there and we are currently looking for those opportunities.
Given that you did so well in less than eight years, why did you consider selling the ISE to Eurex, losing at least some of your independence? For the ISE to grow to the level where we now are with Eurex would have meant enormous risk, been very costly and taken a long time. We now have offices around the world, relationships with many regulators and multiple exchanges, a distribution network spanning the planet. I work with a group of people who are as hungry as we are to grow the business and not be satisfied with what we have achieved.
What people forget about the ISE is what it was at the beginning. It was scary. When we applied to become an exchange, the Securities and Exchange Commission had not approved a new exchange since 1973. Trading options electronically was something that an exchange had never done before.
When I was talking about systems processing at that time 25,000 quotes per second, (technology provider) OMX thought I was crazy. Now we handle 400,000 quotes per second on our OMX platform. Then, we were designing the technology that nobody could even fathom. This has changed over time, but the ISE was a very special example in the markets where there was no other beacon to follow.
Part of the enormous growth in options volume resulted from the entry of new market participants. What motivated their interest? The market structure (for options) was not very conducive to ... institutional investors; it (volume) was about 85% retail. That business did not grow, with about 1 million contracts a day. Turnover in that retail base is incredibly light.
Technology was just the enabler of the business model we created: We were going to show you a quote on one screen and you could trade, based on the information on that screen. This attracted a lot of new liquidity providers Morgan Stanley, Deutsche Bank, Bank of America who had not been liquidity providers in the options exchange model to that point, without technology.
You need to provide institutional investors a product that meets their need. If you define options as a non-core holding, you need to predict how it can be used to protect or enhance their core holding. Institutions now account for an estimated 50% of volume at the ISE.
Contact Isabelle Clary at [email protected]