Plumbing the World’s Markets: The Story of ICE

Plus: Online Lending, Regulatory Complexity, FedNow

Issue #13 of Net Interest, my newsletter on financial sector themes. Welcome to all those who’ve signed up since last week—we’re now over 3,600 subscribers, which is incredible! Every Friday I go deep on a topic of interest in the sector and highlight a few other trending themes underneath. If you have any feedback, reply to the email or add to the comments. And if you like what you’re reading, please do share and invite friends and colleagues to sign up.

Plumbing the World’s Markets: The Story of ICE

Last week the owner of the New York Stock Exchange announced that it’s getting into the mortgage business. At first glance these businesses look like they have nothing in common. One allows people to trade stocks between each other, which they do in huge volumes and at high velocity. The other allows them to buy houses, which tend to be less frequent and more considered purchases. Not the most obvious of bedfellows.

So what’s going on?

Broken down into their core elements, the process of trading stocks and the process of taking out a mortgage are not that different. In both processes there’s a price discovery part, a closing part, a settlement part and at the very end there’s a piece of data.

In the very old days these parts were all conducted manually. Price discovery in stocks happened on the floor of the New York Stock Exchange and the other parts of the process happened in smoky offices nearby. More recently of course, trading has gone electronic. Earlier this year Covid caused the New York Stock Exchange to close its floor for three months—the longest period it’s been out of action in its 228 year history. The surprise is that it reopened at all.

In contrast, the mortgage market has been less quick to adapt to technology. Mortgage broking is not the job it was before the financial crisis, but there are still lots of mortgage brokers around. They begin the mortgage process by helping to match borrowers with lenders. A paper trail then emerges which snowballs its way through closing, settlement and registration. More recently some of the customer-facing parts of the process have gone electronic but at the back-end printers still operate at full tilt.

The parent company of the New York Stock Exchange is Intercontinental Exchange Inc. (ICE) and its founder and CEO, Jeff Sprecher, has made a career out of analog-to-digital conversion. He’s done it in energy trading, he’s overseen it in equity trading, he’s doing it in fixed income trading and now wants to give it a go in mortgage. 

He also happens to be a very insightful man. Few entrepreneurs have emerged in financial services to run multi-billion dollar businesses and fewer still have done it on operating grounds, without recourse to financial engineering. This note looks at his track record. Having installed the plumbing for some of the world’s biggest markets, will Jeff Sprecher be able to do the same for mortgages?

Ice Ice Baby

Intercontinental Exchange was founded in 2000 in Atlanta, Georgia. Several years prior, the electric power industry in the US had been deregulated. Previously, surplus energy was bought and sold between power plants; now a trading market opened up. Sprecher had already seen the benefits of deregulation. Since the early 1980’s, private companies had been permitted to build and operate their own power plants and Sprecher joined a California-based company, Western Power Group, to do just that.

From his vantage point within the industry Sprecher saw the benefits of energy trading and spotted a company in Atlanta that had set up an electronic trading platform. Sprecher bought the company for a dollar – it wasn’t doing very well – and invested more of his own money in the business. For a while he commuted between California and Atlanta, managing his two businesses, but eventually he went all in on the trading side.

The only problem was that he didn’t know very much about trading.

“I wanted to create, essentially, an online platform where consumers could buy and sell electric power. And I knew the electric power industry. I had no idea how to do a platform. I didn't know how to code. I'd never traded.” [Source]

His big problem was that unlike other contracts, electric power couldn’t really be stored. Buyers and sellers would trade physical electrons between substations around the country. This reduced liquidity in the market, leaving it prone to squeezes. 

Fortunately he was a big user of eBay (car parts, apparently) and that gave him the inspiration for cash settlement of energy contracts.

“Because I was an eBay user and because back in the day we were all worried about putting our credit cards on the Internet… I saw the value of PayPal, and one of the first things I did once we launched our trading platform was try to figure out the money movement in the settlement piece. It really was an emulation of what was going on in the Internet at the time and today in financial services we call that clearing. In the consumer world, you call it payments.” [Source]

The business took off. Its early success was based on two factors. First, Sprecher gave away 80% of the company to his customers as an incentive for them to trade at his venue. Goldman Sachs, Morgan Stanley and several of the largest energy companies all became involved. Second, the company had a lucky break when Enron went bust. Enron had been trading with counterparties on its own account, but after its collapse, people wanted a neutral counterparty to trade with. 

“I tell people all the time that you do need luck in business, there's no question, but to a certain degree you have to be prepared to accept the luck, you have to be in the moment, and when the opportunity presents itself you have to be willing to seize it.” [Source]

A Twenty Year Buying Spree

The company was also helped by its early diversification away from power and into oil. In 2001 it bought the International Petroleum Exchange in London. The exchange had a floor near The Tower of London which people would go and visit long after other open outcry venues had been closed. It traded oil futures contracts and had around a 25% share of the global oil futures market.

Within a few years Sprecher migrated the exchange over to an electronic platform. As well as reducing operating costs, the shift allowed him to broaden out the range of contracts traded. The open outcry system limited the number of contracts that could realistically be traded—the International Petroleum Exchange traded four. Today, on an electronic platform, it trades a thousand.

He also added clearing. This is an important adjacency to trading. Rather than having counterparties deal directly with each other, which led to all sorts of problems with Enron, it allows them to transact via a third-party. The third-party ‘clearing house’ values contracts daily, maintaining appropriate margin balances from the counterparties before finally settling the contract at expiry. In London, ICE had originally outsourced clearing to a specialist clearing firm, but soon Sprecher decided to build his own, the first new clearing house to be established in London in over a century. 

The International Petroleum Exchange deal set the stage for further acquisitions. Over the past 15 years ICE has made around 20 acquisitions. In 2007 it bought the New York Board of Trade, taking it into agricultural commodities. In 2008 it bought Creditex, taking it into credit default swaps. In 2010 it bought the Climate Exchange, taking it into exchange-traded emissions. And then in 2013 it famously bought the New York Stock Exchange to take it into equities.

Today ICE offers trading across a huge range of products. Its core business benefits from obvious network effects. More people trading creates deeper liquidity, which drives better price discoverability, which draws more people to the market. The clearing function keeps customers sticky and throws up a barrier to entry (there’s a reason a new clearing house hadn’t been established in London in over a hundred years). In energy, ICE competes really only with the Chicago Mercantile Exchange.

“And sort of taking a page from Amazon…what started with books pretty quickly so you could really – anything that people wanted to exchange, so once we had a payments network and a trusted distribution network, you could put anything on it. And so what we've done is gone around the world and tried to move through every financial asset class and every global jurisdiction that we can get access to.” [Source]

Sprecher typically looks for one of three things in an acquisition candidate: something which can enhance the company’s overall network, new content, or an underperforming business he can turn around. Sometimes an acquisition target can offer more than one thing. For example, the New York Board of Trade brought with it a US clearing house – good for the network – and new content in the form of agricultural commodities. The New York Stock Exchange was a turnaround. 

Acquisitions that enhance a network can be hard to value because the sum-of-the-parts can be greater than the whole, but it’s difficult to determine by how much. Sprecher has observed that once integrated into ICE, target company growth often accelerates. This explains why he is happy to pay up. In that very first deal, for the International Petroleum Exchange, he went in with an offer twice what was on the table. 

“I've never been the low bidder. And in fact, you know, normally, I've never been, in the negotiation, the person that comes in and says well I need another five cents off the table, I'm usually the one that says, I'll give you five cents if we can close this deal quickly and make it seamless. Because, you know, my company hasn’t been about some tiny little incremental change, it's been about seizing opportunity to make big change and to make big change you gotta take big steps, and you can't let these little negotiating details get in the way.” [Source]

Jeff Sprecher’s Insights

Many entrepreneurs become wildly successful on a single, valuable insight. Others have several. Jeff Sprecher is one of those that has had several. I count three:

The first is the analog-to-digital shift. He was early to see the upside available from shifting trading from a manual process to an electronic process. It’s an inherently disruptive insight because it requires overturning centuries of entrenched practice. Like in other industries where this has happened, it helps to be an outsider. 

“If you go into an industry that you don't know a lot about it forces you to ask a lot of questions and, and to take a fresh perspective, because you have no other perspective and and that's what we've done at ICE for the last 20 years.” [Source]

While this insight is less radical today than it once was, Sprecher has evolved it as technology has caught up. Now that everyone has a smartphone in their pocket, finding buyers and sellers isn’t so hard. In the old days of the New York Stock Exchange, people met at the Tontine Coffee House to trade; now anyone at all can digitally connect to the Coffee House.

As a result value has shifted away from the price discovery part of the trading process, to the other parts—the clearing and settlement. To reprise Sprecher’s eBay analogy, the value of PayPal is now over five times greater than the value of eBay. As other industries have shown, analog-to-digital isn’t just about shifting to a lower-cost channel, it’s about shifting where the value is captured. 

The second insight is to see regulation as an opportunity. Many in financial services complain about the burden of regulation, but for some it can offer benefits. Sprecher’s first break came in California after the deregulation of power plants; ICE itself was formed after further deregulation. Since then Sprecher has benefitted from greater regulation in financial services. The regulatory requirement for credit derivatives to be cleared led to a business opportunity for ICE—the company now clears over 90% of the world’s flow of credit default swaps. And new financial regulations in Europe (MiFID II), which impose onerous reporting requirements on traders to demonstrate best execution, led ICE to transform its data and analytics business.

(Of course, being on the right side of regulation is another luxury of the outsider; some of ICE’s more established businesses like the New York Stock Exchange find themselves on the other side of it—the subject of a future post.)

The final insight is the value of data. 

The exchange business revolves around data—pricing data, behavioural data, settlement data. Sprecher says, “And so largely, my business, my company is a database operator.” [Source]

It used to be that most of this data was a byproduct of trading activity. Some value was retained by selling it, but not much. In some markets, notably rates and commodities, the data evolved into benchmarks around which derivatives were built, pulling in more trading activity.

Increasingly, however, data is central to the model. At ICE, this view crystallised in the acquisition of Interactive Data Corp (IDC) in 2015. IDC is a bond database, covering 3 million securities at the time of acquisition; up to 13 million now. The acquisition doubled ICE’s data revenues and provided the foundation for a data business that was no longer captive to the exchange business. 

True to form, ICE did not quibble on price, outbidding two other firms for it. At the time, people thought the acquisition was expensive (“Man, you've got this great trading and clearing business, and you paid 16x for IDC? That's insane for 16x.”) But its stand-alone growth rate has since doubled and the deal cemented Sprecher’s view of the value in data: “I mean if I could have gotten every other data asset in the world at 16x, I take them all right now.” [Source]

For Sprecher, data assets are valuable because unlike trading, “you build it once and you sell it multiple times.” This makes selling data less sensitive to the cyclicality inherent in trading. Around half of the company’s revenues are now subscription based. 

It's also where he sees growth:

“I go out and meet my shareholders quite often and [they] ask that question all the time: Is data the future? And I always look down, in front of them is a smartphone, which none of us had 10 years ago, and I point to it and say, Are you consuming more data today than you did 10 years ago? And is there any doubt in your mind that 10 years from now you're gonna consume more data than you do today?… And so I don't know what the future is going to entail when it comes to technology but I know it's going to consume a massive amount of data.” [Source]

Although financial data is available from multiple sources, it has recently been consolidating around fewer players. Since the ICE deal with IDC, the London Stock Exchange announced it wants to buy Refinitiv. The consolidation is happening partly because buyers want to work with only a small number of vendors for security reasons, and partly because of the scale benefits of pricing. The unit price of data is coming down, but as long as the demand growth is there, the wallet is growing (helped by regulation). 

Leveraging the Insights into New Markets

Sprecher’s insights are sufficiently general to have application more broadly. Over recent years he has looked to apply them in new markets, specifically in fixed income, in crypto and in mortgage. 

Fixed income is clearly the closest to his core markets. Because there’s so little standardisation in the fixed income market, it remains a largely analog market. There’s only one Citigroup common stock, but there are tons of Citigroup bonds outstanding, each with different maturities, covenants, coupons, and liquidity profiles. Only around 20% of the market currently trades electronically. Rather than enter the market via execution (like MarketAxess did years earlier), ICE has entered via data infrastructure. Interactive Data Corp kick-started this process but since, the company has bought indices (from Bank America) and trading technology (BondPoint). 

In crypto the company set up a business called Bakkt in 2018. It was originally run by Sprecher’s wife, Kelly Loeffler, until she won a Senate seat last year. It acts as an aggregator and marketplace for digital assets. It’s a relatively small investment, but it keeps ICE close to this fledgling market.  

Finally, there’s mortgage.

Following his playbook around data, Sprecher bought a business called MERS (Mortgage Electronic Registry Service) in 2016. It’s a database where ~85% of mortgages in the US reside. Sprecher analogises it to The Depository Trust & Clearing Corporation (DTCC) in equities, what he calls the ‘golden record’. Then last year he acquired a business called Simplifile, which runs a network connecting mortgage settlement agents to local counties, where mortgages need to be registered, in order for documents to be shared electronically. His latest acquisition last week was for Ellie Mae which runs loan origination software for mortgage lenders. By combining all of these acquisitions, ICE creates a single digital ecosystem for the mortgage process. Its goal is to operate the digital rails of the mortgage industry for a fee, while also creating a data asset which it can monetise. 

The Ellie Mae acquisition raised questions about valuation. The company had traded less than 18 months earlier at a third of the price ICE is now offering to pay. Partly that’s because the business has performed better than expected. At the time of the first deal, management anticipated US$620 million of revenue in 2020 and US$201 million of EBITDA. The company now anticipates US$900 million of revenue in 2020 and US$470 million of EBITDA. Partly it’s because risk has been reduced, with Ellie Mae having successfully migrated to the cloud. But it’s also consistent with Sprecher’s view not to quibble over price. 

The conversion of the mortgage process to digital is still in its early stages. Like in other areas, Covid is accelerating it. Electronic mortgage closings (eNotes) have been available in the US for a while; adoption recently jumped to 3% from 1% a few quarters ago. But for the most part mortgage transactions are still largely paper-based and can take months to settle. Venture capitalist Josh Wolfe likes to talk about ‘directional arrows of progress’. This seems like one of them, and Sprecher has the track record to do it. 

“The analog-to-digital conversion, once it reaches a tipping point, you can't stop it regardless of what the microeconomic situation is.” [Source]

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Online Lending

Last week’s Net Interest looked at online lending: the good, the bad and the ugly. Since publishing, a few more data points have emerged. Kabbage is reportedly in talks to sell to American Express for US$850 million. That’s less than the US$1.3 billion it was last valued at when Softbank injected equity in 2015, but it would be a lower writedown than the one OnDeck shareholders took from the peak. 

According to data from dv01, overall online lending in the US is not performing that badly. In mid-April, impairments reached an all-time high of 16.5%, but as of mid-August they stand at 9.5%, recovering two-thirds of their COVID-related increase. However, in the small business segment things are likely worse. Bank of America reported that in June, 14% of its small business borrowers had sought deferral, compared with ~5% of its consumer borrowers. OnDeck and Kabbage both do small business loans, although with a different mix—Kabbage is smaller, shorter term loans for working capital, whereas OnDeck is for larger projects. American Express may soon lift the veil on how they compare.

Regulatory Complexity

The Bank of England staff blog highlights a paper which examines whether regulatory complexity has increased since the financial crisis. The reforms following the crisis led to an increase in UK banking regulation from almost 400,000 words to over 720,000. The paper measures complexity through the network of cross-references between individual rules. It concludes that to follow current regulations you need to traverse many more long chains of cross-references than was the case pre-crisis. In other words, the rulebook has grown more complex.

That’s no surprise. The irony is that in their mission to rein in the large banks, regulators have created a barrier to entry which entrenches their position. It’s higher cost for everyone, but small banks will struggle to compete. 


The Federal Reserve announced details of its instant payments initiative, FedNow, this week. FedNow is expected to launch in 2023 or 2024, a full sixteen years after Faster Payments was introduced in the UK. Unlike in other markets the Fed has moved slowly not to step on private sector toes. In the void, a plethora of alternatives have emerged including Venmo, Cash App, Zelle, Facebook Messenger, Visa Direct, Mastercard Send. A couple of years ago the big banks got together to design their own system – The Clearing House RTP system – which works by them pooling equity in an account at the Federal Reserve. 

However, while all this has been going on, other countries have taken a more centralised approach. According to FIS there are now 54 real-time payments systems operational in the world, up from 14 in 2004. The benchmark is India which operates one of the most evolved and sophisticated public digital payments infrastructures in the world. Normally market solutions work best, but in a highly fragmented market where interoperability is key, a public solution can save a lot of time and money.