New York Stock Exchange (NYSE)			John Thain was recently named CEO of Merrill Lynch & Co. This Gartner Fellows interview was conducted while Thain was CEO of the New York Stock Exchange. Established in 1792, the New York Stock Exchange (NYSE) is by far the largest cash equities market in the world today. The market capitalization of companies listed on NYSE ($27 trillion) is greater than the market capitalization of all companies listed on the London, Tokyo, NASDAQ and Swiss exchanges combined. The NYSE has certainly seen many changes during its 215 year history. In 1886, more than 1 million shares were traded for the first time. In February of this year, the NYSE saw its first 4 billion share day. That record stood for just three months, until June, when the exchange had its first 5 billion share day. How much more trading volume can the NYSE handle? Why do we even need exchanges in today's world? How will capital be raised in the future? In 2004, the NYSE appointed MIT undergraduate and Harvard Business School graduate John Thain to help formulate answers to those and many other questions. Recently, we sat down with Mr. Thain in his office at the Exchange to explore the future of corporate regulation, competition in capital markets and the role IT will play in the securities trading industry. NYSE CEO John Thain was interviewed by Ken McGee on 28 June 2007 I.  The Effectiveness of Recently Imposed Securities Regulations Gartner: I'd like to start our discussion with the topic of corporate regulation. Did the U.S. over-regulate with the Sarbanes-Oxley Act of 2002? Thain: Well, the answer to that's a little bit complicated, because the law itself, as it was written, is fine. Most of Sarbanes-Oxley is good. I think it led to better corporate governance and better structures for the board. It certainly shifted more power to the boards from the CEOs. And even Section 404 of Sarbanes-Oxley Act of 2002: Management Assessment of Internal Controls, the way the law was written, if you read it, is actually fine. It simply says that companies should have good internal controls, and there should be a review of those internal controls. So, the problem was not the law itself, but the way it was implemented. And the problem was that the Section 404 piece of it was implemented without any guidance as to materiality, as to where the real risks were. And this was coming after Enron, WorldCom and Arthur Andersen. So, without that guidance as to how the 404 process should be implemented, the accounting firms took the absolute most-conservative, most-protective-to-them and most-expensive approach. They did not apply any forms of materiality standards, they did not apply any risk-based approach, and so the 404 process became incredibly expensive — many, many times more expensive than the SEC had estimated — and very time-consuming. And so most CEOs that I talked to would say that, yes, there's value to that internal review process, but the time and expense were many times greater than any value that they got. And so the problem is really the implementation, not the law itself. Gartner: If it's the regulatory interpretation, not the law itself that perhaps went beyond what people were reasonably expecting, what are some of the things that you hear from CEOs that they would like to see changed? What would you like to see changed? Thain: Well, we have lobbied the SEC and the Public Company Accounting Oversight Board over the course of the last year. So, I think that the new revised implementation of 404 — as well as the new Audit Standard No. 5 (AS5) replacing AS2 — will in fact result in a 404 process that is more materiality-based, is more risk-based, and is less expensive. So, I think we have to make sure that the changes that the SEC and the Public Company Accounting Oversight Board want to see happen get implemented at the audit partner level; we have to make sure the desires and the ideas at the top are pushed down into the field. Assuming that works, the cost of 404 will actually come down. II.  The Future of Stock Exchanges Gartner: What future do you see for exchanges over the next 10 to 20 years? Thain: I guess I'd say that, over the next five to 10 years, you will see a small number of large multiproduct global exchanges develop — probably three or four. We will clearly be one of those, but there will be others. You see them starting to form now. So, we and Euronext (along with our position in India and Japan) are the biggest, because our markets are the biggest. But you see Deutsche Borse coming into the U.S. to buy the International Securities Exchange; you see NASDAQ buying (Nordic stock exchange operator) OMX; you see now the London Stock Exchange buying Borsa Italiana. That gives you the framework of what will probably be three or four — maybe four or five — multiproduct, global exchange groups. And then there'll be lots of little ones. There'll be little ones for two reasons: Almost every country in the world has its own exchange — even supposedly Communist countries like Vietnam have two exchanges — and those exchanges serve their local markets. They provide capital to local companies; they provide investment opportunities for local investors — and that's good. And then, of course, there are really low barriers to entry to new exchanges. So, people can always create new ones. But I think that the model will be a small number of multiproduct global exchange groups, and then lots of smaller ones — either local ones or new ones Gartner: Must an exchange — one of the big ones — actually acquire or merge with another exchange in a particular country, like China or India? Or are there other ways that your goals can be met without having to do another Euronext deal? Thain: I think the answer is that there are a number of ways in which you can create those linkages. I think you will need to have a presence in the three main "time zones" in the world, which are the U.S., the European and the Asian time zones. And I think you need to do that to be able to offer your customers the full range of trading opportunities. With ourselves and Euronext, we merged. I don't think that's the only model. I think, as a matter of fact, in Asia, that will probably not be the model — at least for the foreseeable future. I think in Asia there will be more strategic partnerships, which may include equity ownership stakes — perhaps cross-owners, ownership stakes. You know, we bought 5% of the National Stock Exchange in India; we have a strategic alliance with the Tokyo Stock Exchange, which I think eventually will lead to either an equity investment or perhaps cross-ownerships. But I don't think that in Asia you will see full mergers, like NYSE and Euronext. And I think that's okay. The models can be different. But I do think you need to have a presence in the three main time zones. III.  People versus Technology on Stock Exchanges Trading Floors Gartner: When it was announced that you were coming over here, everyone was trying to analyze your MIT background, thinking, "John's going to change the world, and the trading floor is going to go away." When people ask you, "John, why do we need those people downstairs on the trading floor?" What's your answer? Thain: The answer is, when something unusual happens, whenever something bad happens, whenever there's a mistake, the people's judgment and people's ability to recognize issues or problems make stocks trade better. So this morning, the fact that a person could recognize that there was an error in the orders that were coming in prevented losses that could have been hundreds of millions of dollars. Gartner: Are those volatile situations frequent or big enough to warrant keeping people, specialists and so on, on the NYSE floor? Thain: In the last three years, we've moved 60 companies from NASDAQ, which is obviously totally electronic, to here, in terms of listing. The intraday volatility of those 60 (companies) went down between 40% and 50%. So, it's a big difference in how stocks trade, when they have a specialist on the floor. That's a real cost. Companies pay for volatility. It increases their cost of capital. And so, there is real value to the floor, and I believe it will continue to exist. Gartner: So, no technology that we know of can supplant these people? Thain: Correct. Yesterday, we traded 1.7 billion shares. We need the technology to do that, but that doesn't supplant or take away from the value of the human judgment. So, we're giving the brokers and the specialists much more technology; they're actually interacting with the market much more electronically, but their judgment is still there. IV.  Competitiveness Gartner: What are the concerns about the state of competitiveness of U.S. stock exchanges? Thain: The U.S. and the NY Stock Exchange are still the financial capital of the world. The value of the stocks that trade here is $25 trillion. So, it's four or five times bigger than any other equity market. And we are still — no matter what you read about London or Hong Kong or someplace else — the leader in the financial world. But we can't be complacent about that. Other venues, particularly London, are catching up. Gartner: By what metrics? Thain: One of the metrics that I use, if you look at the 25 largest initial public offerings (IPOs) in the world in 2005, only one was listed in the U.S. In 2006, of the 25 largest IPOs in the world, we did much better — two were listed in the United States. And that's very different from five or six years ago, when at least half of them would have been listed here. So, there's something that's causing some number of companies to choose not to enter the U.S. marketplace. And we know who these companies are, so we go ask them. We say, "Why did you choose to list in London or Hong Kong rather than list on New York?" And the answers were basically five reasons. The first was Sarbanes-Oxley Section 404 — the cost and the expense. As I just said, we fixed that. Or at least we believe we have. The second was the lack of accounting convergence. So, the fact that if I'm an international company using international accounting standards, I have to reconcile the U.S. Generally Accepted Accounting Principles (GAAP), which is expensive and not terribly valuable. The SEC has recently said that it is now going to allow International Financial Reporting Standards (IFRS) financials in the U.S. without reconciliation to U.S. caps. So, those are two — and by the way, we've been working on these two things. The third reason is the litigation environment in this country, particularly the class-action lawsuits. We really haven't gotten legislative fixes to that, but the recent Supreme Court rulings over the last couple weeks are actually quite positive on that front; to make it much more difficult to get certified as a class, and to make that standard — the burden of proof is higher. So, at least we're getting some help from the Supreme Court on the class-action litigation. The fourth reason is the duplicative and, I would say, overly enforcement-oriented regulatory environment. You heard U.S. Treasury Secretary Henry Paulson talk a little bit about that — and I think that's actually also getting better. But a lot of times, people contrast it with the Financial Services Authority (FSA) in the U.K., where they're much more interested in fixing problems than in handing out big fines. And the last reason is something we can't do anything about, which is that the rest of the world's capital markets are maturing. It used to be the case that, if you wanted to raise billions of dollars or euros or whatever, you had to come into the U.S. market, because that's the only place you could raise that much money. And that's not true anymore. You can raise billions of dollars in Europe; you can raise billions of dollars in Hong Kong. And so, that just tells you that the U.S. has to be more conscious of its competitive position, because it's not just going to attract companies here by default. Gartner: Last November, the heads of the largest accounting firms issued a joint statement supporting, among other things, more-frequent financial reporting. Recently, we interviewed the CEO of KPMG, and he echoed the idea. But I'm wondering about in emerging markets — Thailand, South Korea, India, China — where leaders could say: "For us to compete against companies that are a hundred years old and so on — and if we want to attract the world's capital to us — let's give that investor confidence a shot in the arm by reporting more frequently on the health and welfare of their investment." Do you see that as a likely, logical leap? Thain: I don't think it's likely, and I don't think it's logical either. I don't think it would be better for investors. And I haven't heard any jurisdiction where anyone's contemplating that. And I think actually it would be a negative. Companies wouldn't want to be listed in such an environment, because it's enough of a burden to report quarterly, let alone monthly. So I don't think so. V.  A CEO's Views on IT and Innovation Gartner: Can you site three technology enhancements you'd like to see at the NYSE? Thain: Well, the biggest thing is we need to continue to be faster. When I first got here, it took an average 12 seconds to execute a trade on the floor. When we automated more of our systems a year ago, it took 300 milliseconds to execute a trade on the floor. Today, it takes about 80 milliseconds. By the end of the year, it'll be sub-10 milliseconds. Just to give you another idea, the greatest number of shares we've ever traded in a day is 3.1 billion shares. As we have adjusted our system and upgraded the capability of our system, we tested our system a month ago, on a Saturday — that's 3.1 billion shares in a day — we traded 6 billion shares in two hours. So, the system capacity is much, much greater today — and it needs to be. There's no way we could trade 3 billion, or even 1.7 billion shares with paper. So, the technology has allowed us to trade higher volumes at faster speeds, and be more responsive to what at least some segment of the customers want, which is speed of execution. Gartner: You said, you did 1.7 billion shares yesterday, and that you did a test on a Saturday recently that took you up to 6 billions shares. Could it have been 9 billion? I mean, how much can you do now? Thain: Well, we traded 6 billion shares in two hours, so we could have traded 15 billion shares. Actually, the constraint is not the number of shares. The biggest constraint right now is message traffic. Because so many of the messages (messages are "buy," "sell," "cancel," "replace") don't result in trades, it's really message trafficking that's the biggest constraint — not trades. We could trade 15 billion shares — we'd like that, by the way. We're running now at a rate of 30,000 messages a second. That's what's causing the biggest capacity issue. And we're in the process of actually building out our system to handle 64,000 messages a second. Gartner: When you look at new products, new ideas — when you're heading into new areas — what do you expect from your IT professionals? Thain: I expect them to build state-of-the-art systems that never break, that never have any technology problems, and that are relatively low cost compared to competitive systems. That's all … [chuckles]. Gartner: But when it comes to innovation, how often do IT people knock on the door saying, "Hey, I have an idea." Do you see innovation coming from IT? Thain: The answer is yes. The exchange, historically, was not known for its innovation, and I think it's getting much better about that. Now part of it was integrating the archipelago culture and people, because they were much more innovative, but there's no question that as we have evolved, over the last few years, we're seeing all kinds of new, innovative technologies — whether it's our bond trading platform, which we just created, or transact tools, which really is state of the art. Gartner: I'm sorry, John, I'm not talking about the tools. I'm talking about the products. For example, who came up with the idea for the new NYSE Hybrid Market product? Thain: I don't think any one person came up with that, because that's really a collective creation, because what we were doing was, we were responding to a set of customer needs. There's a set of customers who said, "We want to trade instantaneously, electronically and anonymously. We do not want our orders being routed to the floor." So, we said okay — great. We have to respond to that group of customers, because if we don't they're going to go trade somewhere else. On the other hand, we have brokers on the floor who say, "We need tools to do the following things." We have specialists on the floor who say, "We need tools to do the following things." So, Hybrid was a collective effort of building the tools that brokers needed, the tools the specialists needed, and responding to the customers. And it was created really over the last couple of years, by a team of people, basically listening to our various constituencies. Gartner: As CEO, must your IT staff be expert in the securities industry? Thain: It's a really interesting question. The answer is, I believe that IT people need to understand the business. So that if you just have IT people who just write code and they don't understand the business, then they're never going to be as valuable or as good as they need to be, because they have to understand the business to be able to anticipate what the business really is. Gartner: Apart from on-the-job experience though, how can they best evidence that? Would you recommend IT people get professional certification in the securities industry? Thain: No, you've got to do it on the job. You learn it on the job. But it's important that they understand the business, because that makes them better IT people. VI.  Closing Comments Gartner: What are some of the revolutionary things you'd like to do at the NYSE? Thain: Well, one thing I said is we need to be faster. We definitely have to continue to upgrade our system to be faster. We have to be into single-millisecond execution times. And we will get there, I think, within the next six to 12 months. The second thing, just in terms of our global footprint, we have to have a presence in Asia. I said that we have a strategic alliance with Tokyo, and we have an investment in India; we have to have a position in China. That might take a little bit longer, but in my wish list of things, I want to have a position in China. I guess the third thing is I'd like to have a bigger position in derivatives, particularly in the U.S. If I could get single-millisecond execution speed, a position in China and then a bigger position in derivatives, that would pretty much round out the business of the company, and I think we'd be very balanced. Gartner: So we would know that John Thain was here? Thain: Exactly. Gartner: John, thank you very much for your time.