Archipelago Buys Pacific Stock Exchange

By announcing its intention to acquire PCX Holdings, the parent of the Pacific Stock Exchange, Archipelago Holdings becomes the first U.S. firm to offer electronic trading of both stocks and options.

Archipelago Holdings Inc. has announced its intention to acquire PCX Holdings Inc., which is the parent of the Pacific Stock Exchange. The deal brings Archipelago the exchanges electronic system for trading stock options, and the self-regulatory license that has allowed the exchange to police itself. It also includes PCXs 20 percent stake in the OCC (Options Clearing Corporation).

Archipelago will become the first U.S. firm to offer electronic trading of both stocks and stock options. "Options are growing like crazy, the use of electronic trading for executing options is growing, so we plan to be right at the front edge both in terms of technology and in terms of services that we can deliver," said Jerry Putnam, chief executive at Archipelago.

The offer is for $50.7 million, 20 percent of which is composed of Archipelago stock, with the remainder in cash. The deal is expected to close in mid-2005.

Philip D. DeFeo, chairman and CEO of PCX Holdings and the Pacific Exchange, said, "We believe that Archipelagos thinking on market structure is clearly aligned with ours, and expect no changes in our options market structure in the immediate future.

"We expect that Archipelagos strong relationships within the trading community and proven technical prowess will accelerate the ultimate development of an all-electronic, floor-independent options marketplace," DeFeo said.

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Ninety percent of PCXs trading volume takes place on its internally developed electronic system, which allows traders anywhere in the world to buy and sell options. Daniel Goldberg of Bear Stearns said the takeover is a plus for Archipelago, noting, "Future synergies are expected to rise primarily from the conversion of PCX to a fully electronic exchange from what today is, in essence, a hybrid market."

Archipelago will use its own brand name, ArcaEx, for the options exchange, and once the deal closes, the Pacific Exchange name will be discontinued. PCX sold its stock trading operations to Archipelago in 2000.

The exchange has a physical presence in San Francisco at its Montgomery Street trading floor, where about 260 employees and 200 or so brokers trade in a 12,000-square-foot hall. Plans to keep the floor open until at least next year are unchanged.

This acquisition is yet another in the continuing consolidation of the trading center industry. Nasdaq bought out Brut last year, and Instinet has put itself on the market. Rumored partners for Instinet include Nasdaq and the NYSE (New York Stock Exchange), as well as others.

"We believe Instinet could follow the lead of Archipelago and combine with an exchange," Goldberg said. He added that he would not be surprised to see the Chicago Mercantile Exchange or the NYSE make a move in the direction of consolidation.

Although many questions remain regarding integration, a combination of equities trading and options trading on a single electronic platform would be a significant advancement. Goldberg said it appears that initially, two separate technology platforms will run side by side (i.e., one for equities and one for options). This type of combination would fulfill the hidden demand that analysts believe exists today within the derivatives market.

U.S. exchanges have struggled with regulatory problems and thinning margins in equities trading since the decimalization of stock orders. Branching out into derivative trading has become a necessity to maintain profitability.

A more integrated combination of the platforms will provide the opportunity for Archipelago to offer more complex trading products, thus further increasing volume growth. According to Archipelago management, the firm has a goal of growing the PCX options business from a market share of about 9 percent today to more than 20 percent over time.

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