Welcome to another issue of Front Month, a newsletter covering the biggest stories in exchanges & market structure every Friday. If you have questions or feedback, please reply to this email or find me on Twitter. If you like this newsletter and want to follow the exchange industry with me, please hit the Subscribe button below & be sure to share with friends & colleagues:
News
NYSE and Intrinsic Exchange Group Partner to Launch a New Asset Class to Power a Sustainable Future: The normal lifecycle for a successful company usually involves raising capital. Companies can either raise money by getting a loan from a bank, or they can raise money by selling equity in the company itself, giving investors a chance to participate in the future upside of the business. Many businesses raise equity capital by holding an IPO on the New York Stock Exchange & becoming a publicly traded company. Investors trade these equity shares in the public market & try to value them by projecting future cash flows owning these equity shares will give. This is & has been the normal structure of the equity market for centuries now.
On September 14 the NYSE published a press release outlining a new use case for its listing venue:
“The NYSE has developed a new kind of listing vehicle that will be called a natural asset company, or NAC. Using NACs, governments, farmers, and other owners of natural assets will be able to form a specialized corporation that holds the rights to the ecosystem services produced on a given chunk of land, services like carbon sequestration or clean water. Then the company will tap the U.S. public markets by way of the NYSE like any other entity would. The difference is that instead of using the capital raised to shore up a balance sheet, fund M&A, or buy back stock down the road, NACs will use the funds to help preserve a rain forest or undertake other conservation efforts, like changing a farm’s conventional agricultural production practices to regenerative methods.”
(Source)
Imagine you’re the Costa Rican government. You’ve published global & domestic commitments to improve the environment in your nation. Improving the environment costs a lot of money. You can try and borrow money from your citizens or other nations to pay for the needed environmental improvements, but adding billions of dollars to your national debt doesn’t seem very attractive.
Or, you can partner with Intrinsic Exchange Group to sell “equity” in your environmental project. There are plenty of ESG-hungry investors and funds that would love to give money to help your nation improve the environment, so why not let them? Even better - unlike debt, equity never has to be repaid. As a government looking to raise capital that isn’t debt, this seems like an interesting option.
Taking a closer look reveals even more attractive qualities about a natural asset company for your government. It’s unclear what investors are actually buying - they’re not buying land and they’re not buying a business with cash flows. They’re buying “the rights to the ecosystem services produced on a given chunk of land, services like carbon sequestration or clean water.” How can investors build a DCF to value carbon sequestration? Does clean water buy back stock or pay dividends?
While we don’t know much about this new “asset class” or its future participants, the above example is likely not far from reality. IEG’s own website lists the below as a project example:
“In Costa Rica, IEG is collaborating with the Government to explore the creation of a Natural Asset Company to value and finance conservation and social priorities and meet national and global commitments.”
(Source)
Much like a SPAC, it is my opinion that natural asset companies are simply another sophisticated way for institutions to separate investors from their money. I’m all for improving the environment and combatting climate change. I would understand if Costa Rica raised taxes on its citizens to pay for environmental projects. I would also understand if Costa Rica supported charities that worked to improve the environment. I do not understand it tapping the public markets to do so. The public equity markets should be a venue for profit generating businesses to raise capital & fund new chapters of growth. It is not a venue for environmental charity.
I’ll end my rant with a joke I think is funny now but may be closer to the truth in just a few years time:
Blockchain for Red-Hot Crypto Solana Restarts After Hitting Snag: Nearly every technology that sees immense overnight success runs into the same kind of problem: not having enough capacity to support the new levels of demand. Servers run out of memory, network bandwidth slows down, and in some cases full-blown outages can happen when demand far exceeds developer’s expectations.
The same kind of problem happens in crypto, with its own set of unique outcomes & solutions. When the summer NFT craze hit Ethereum and activity overwhelmed the network, fees to transact on the blockchain became prohibitively expensive, in many cases pricing out the average retail user of using Ethereum. User feedback was harsh & caused many to start looking for a lower cost blockchain solution.
Enter Solana, the relatively new, high-performance blockchain with an army of HFT firms backing the project on release. Solana offered exponentially faster processing speed compared to Ethereum & nearly-free transaction fees, making the user experience highly attractive for those who were frustrated with Ethereum’s slow, expensive offering.
Throughout August & September Solana’s native token ($SOL) skyrocketed as more and more users converted to the platform:
Then, on September 14 Solana’s network capacity reached its breaking point after a huge wave of activity hit the platform that morning. Instead of transaction fees spiking or slower processing time, the blockchain suffered a complete outage. It took nearly a full day of troubleshooting by Solana’s development team to get the blockchain back online, sparking intense debate among the Ethereum & Solana community. Is Solana too centralized? Can we trust the integrity of a project that can suddenly crash when there’s too much activity on its network?
As a Solana fan & a $SOL owner, I think the outage is notable & worth understanding but not a reason to abandon the project altogether. Disruptive technology is never going to be perfect from day 1, and blockchains have little room for error given 24/7 runtime and high performance expectations. As far as the centralization question goes, I think a blockchain like Solana will ultimately be successful despite not being completely decentralized. At the end of the day users care about tangible benefits - speed, cost, functionality chief among them. If they’re given the choice between a poor user experience & a streamlined one, my bet is they’ll choose the latter even if it’s a bit less decentralized on the backend. I’m willing to trust Solana’s founders through this hiccup & see how community adoption continues from here.
I did a deeper dive on Solana & its HFT backers in a pervious post - you can find it here if interested.
My latest paid post is live - The King Beyond The Wall is a deep dive post on the under-followed but important OTC US equities market along with its top infrastructure provider, OTC Markets Group. Subscribers get immediate access to this post and a deep archive of past exchange & market structure research.
Thank you for your support!
Other Stories I’m Reading
Steven Cohen to Invest in Crypto Quant Trading Firm
OpenSea confirms executive used insider knowledge when buying NFTs
Tradeweb Partners With CFETS To Launch Southbound Bond Connect Extending China Footprint
DTCC’S Project Ion Platform Moves To Development Phase Following Successful Pilot With Industry
Walmart has not partnered with Litecoin, despite reports
Coinbase Applies to Trade Crypto Futures In Derivatives Push
Chart(s) of the Week
MarketAxess held an Investor Day on September 14 where it shared more information about its long-term outlook & main areas of focus. I found two charts particularly helpful to visualize the company’s situation, which more or less confirms my cautious position on the stock.
The first chart plots a range of asset classes by their progress towards electronification. According to MarketAxess, the company’s core products - US High Grade & High Yield corporate bonds - are still early in their analog-to-digital lifecycle and have a long runway of growth ahead as these markets advance along the below S-curve:
I want to temper this view a bit. It’s not a given that all asset classes will converge to 90%+ electronic over time, especially a market as broad & illiquid as corporate bonds. The corporate bond market is heavily skewed towards large block trades that are still overwhelmingly analog to this day. MarketAxess has found success electronifying smaller odd lot trades but has yet to crack the block market. I think dealers will be able to capture a non-trivial amount of market share in block trading for a long time, capping the opportunity MarketAxess has in the medium to even long-term. There’s still growth to be had in High Grade & High Yield corporate bonds, but I think it’s less than the above chart may indicate.
The second chart worth highlighting is a look at what MarketAxess believes is their total addressable market across their product base. Again, I would take this message with a grain of salt - MarketAxess is not going to capture all of this market opportunity given intense competition from Tradeweb & others in the space. For example, given the lack of meaningful changes in share after MarketAxess’s purchase of LiquidityEdge, I’ll believe the US Treasury opportunity when I see it.
What was eye-opening to see was the Emerging Market opportunity MarketAxess believes they’re positioned to capture. Emerging Market bond trading accounts for an estimated ~$90 million in annual revenue today - the above chart implies that figure can 10x over time to become its largest core business. This is supported by management’s goal to have international markets account for 50% of revenue over time, up from ~30% today.
I believe MarketAxess’s story is changing from a US market share battle to a race to capture as much international market share as possible. In my opinion, the company’s Investor Day deck all but confirmed this view.
Thank you for reading this issue of Front Month. Word of mouth is the #1 way others find this newsletter - If you liked this week’s content, please consider sharing with friends & colleagues. Questions & feedback can be sent via email or Twitter.
Disclaimer: I am not a financial advisor. Nothing on this site or in the Front Month newsletter should be considered investment advice. Any discussion about future results or projections may not pan out as expected. Do your own research & speak to a licensed professional before making any investment decisions. As of the publishing of this newsletter, I am long ICE, CME, TW, NDAQ, COIN and VIRT. I am also long Solana.