Billionaire Spencer, Derivatives King, Elbows ICAP Past Cantor
By Stephanie Baker-Said - January 28, 2007
Jan. 29 (Bloomberg) -- Michael Spencer doesn't like talking about his old gambling days. There's the story about him making more money wagering on backgammon than he did at his day job as a broker in the late 1970s, when he says he used to play with London Playboy Club boss Victor Lownes. And then there's the one about him winning a few hundred thousand pounds betting with his office mates on the Rugby World Cup in 1995.
Spencer, 51, would rather talk about the gamble he took when he founded ICAP Plc with a 50,000-pound investment 20 years ago. Since then, the ICAP chief executive officer has built the company into the world's No. 1 interdealer broker -- one of fewer than a dozen firms that execute trades in securities and currencies for banks.
At the time he started London-based ICAP, then called Intercapital, Spencer says, he gave himself 50-50 odds of making it. "We only had a short-term hope that we would survive,'' he says.
His bet has paid off handsomely, making Spencer, who has homes in the British capital and the south of France, one of the richest men in the City of London. Spencer's 20 percent stake in ICAP is now worth 659.6 million pounds ($1.3 billion). ICAP shares were up 16 percent for the year ending on Jan. 26 compared with an 11 percent rise for the FTSE All-Share Index.
ICAP is a hub for one of the hottest markets of the past two decades: derivatives, which are contracts whose value is derived from stocks, bonds, loans, currencies and commodities. On an average day, ICAP brokers handle $1.2 trillion worth of trades, up from $300 billion in 2002. ICAP is also the world's biggest broker for the U.S. Treasury market.
Brokerage Revolution
Spencer is leading a revolution in the brokerage world. Though the system of brokers shouting bids and offers into telephones still dominates, trades are increasingly going electronic. More than 50 percent of ICAP's transactions are done silently via computer, and that percentage is increasing fast.
"There's an inevitable force of gravity toward electronic trading,'' says Geoff Miller, an analyst at Bridgewell Securities Ltd. in London.
The line between traditional exchanges and interdealer brokers like ICAP is blurring as both make a grab for the same trades. The Chicago Mercantile Exchange, which in October agreed to buy the Chicago Board of Trade for $8.5 billion, has teamed up with Reuters Group Plc to expand electronic trading of currencies this year through their joint venture, FXMarketSpace, which will compete head-on with ICAP.
Battles for Territory
NYSE Group Inc.'s planned takeover of Euronext NV, Europe's second-largest stock exchange, will give it control of Euronext.liffe, the world's fourth-largest futures market by volume. ICAP in turn is moving into the exchanges' territory. Since late last year, it has been testing a system that lets investors trade interest rate futures contracts without using an exchange, in a direct challenge to Euronext.liffe.
"We're all moving steadily towards the same territory, and a collision of some sort is inevitable,'' says Spencer, sitting in the board room on the fourth floor of ICAP's Broadgate headquarters, a 10-minute walk from the Bank of England.
"The exchanges have always talked about how they're going to eat other people's lunches,'' he says. "We are potentially in a position where we can compete with them.''
That's why Spencer sat down last summer with London Stock Exchange Group Plc CEO Clara Furse to explore a possible merger. LSE's soaring shares made the deal unworkable, Spencer says.
The LSE's stock price rose 57 percent in the year to Jan. 26. The LSE is now trying to fend off a 2.7 billion-pound hostile bid from Nasdaq Stock Market Inc. Spencer has ruled out a future bid.
Global Economics
"It's inevitable that at some stage a global equity market will emerge,'' says Spencer, wearing a crisp blue shirt, silver cuff links and no tie. "The combination of our technology and the LSE might well have been able to achieve it, but the economics of the transaction are not easy.''
ICAP profits from what Tom Wolfe, in the 1987 novel "The Bonfire of the Vanities,'' referred to as the "crumbs'' of the securities industry. It takes a tiny fee every time it handles a trade. Those crumbs pile up into big profits. The firm's pretax earnings rose 9 percent to 104 million pounds on revenue of 542.8 million pounds in the six months ended on Sept. 30, 2006.
ICAP dominates derivatives that are traded over the counter by brokers barking prices into phones to match orders from commercial and investment banks. Those derivatives soared to $370 trillion in the first half of 2006, up from $197 trillion at the end of 2003, according to the Bank for International Settlements in Basel, Switzerland.
Buzzing Trading Floor
One Friday morning in October, the trading floor at ICAP's headquarters is buzzing, with brokers standing up and shouting orders across cramped desks, where employees sit inches away from each other for 10-hour days.
The emerging-markets group is confined to a glass tank because its members are too loud, their fellow brokers say. It's the kind of job that requires the ability to have one conversation while listening to two or three others -- or what those in the business call brokers' ears.
Frits Vogels, a 42-year-old ICAP executive, leans down with a phone to one ear and a hand covering the other to show how it shouldn't be done. "You wouldn't want to be caught talking like that with Michael around,'' Vogels jokes.
Spencer, who lost his first two jobs in the City, has thrived in the cutthroat world of interdealer broking by staying one step ahead of the competition -- or by gobbling it up. He has outmaneuvered archrival Howard Lutnick, chairman and chief executive of New York-based Cantor Fitzgerald LP and its listed subsidiary ESpeed, which once dominated trading in the $4.4 trillion U.S. Treasury market.
Spencer vs. Lutnick
Bloomberg LP, the parent of Bloomberg News, competes with ICAP and Cantor in selling financial information and trading systems.
Spencer beat Lutnick, as he has several other competitors, with a timely purchase. In 2002, he paid $240 million for Jersey City, New Jersey-based BrokerTec Global LLC, an electronic trading system for U.S. government debt.
He integrated ICAP's own loss-making electronic trading program, called ETC, with BrokerTec and attracted more banks to the system. Daily volume has surged to about $600 billion today from $160 billion in 2003.
ICAP now has a 58 percent share of all Treasury bond trades among banks. ESpeed says it handles 44 percent of benchmark U.S. Treasuries. Cantor's operations were devastated by the 2001 terrorist attack on the World Trade Center, which killed 658 of its New York-based employees, including Lutnick's brother, Gary.
Gobbling the Competition
ICAP is also grabbing a bigger share of the $1.9 trillion-a-day foreign exchange market. In April 2006, Spencer paid $825 million for London-based EBS Group Ltd., an electronic currency trading system set up in 1993 by a group of the world's largest foreign exchange market-making banks. He outbid rivals such as London-based Tullet Prebon Plc, the world's No. 2 interdealer broker.
"EBS was an excellent purchase,'' says Andy Brough, a London-based fund manager at Schroder Investment Management Ltd. who manages 4.5 billion pounds, including ICAP shares. "Spencer's done a great job. Shareholders think he's the man to back.''
ICAP's success has enabled Spencer to live the high life. His name hit the tabloid headlines in 2005 when he paid British chart-topping singer Robbie Williams 1 million pounds to sing at the 50th-birthday bash Spencer threw for himself and 300 friends at Chateauneuf de Grasse near Cannes.
The ICAP chief executive has a personal wine cellar containing more than 1,700 cases, in addition to ICAP's own wine collection, Spencer says. His favorite wine is Cheval Blanc 1982, which retails for 740 pounds a bottle at London wine merchant Farr Vintners Ltd.
Dining with Picasso
Spencer lives in west London's Holland Park with his wife, Lorraine, and three children, and he travels to work every day in a chauffeur-driven Mercedes with a license plate that reads "1CAP.'' A Picasso hangs in ICAP's dining room. A painting of a woman in a red dress by the Scottish-born painter Jack Vettriano graces Spencer's office.
Spencer, who campaigned against Britain's adopting the euro and the European constitution, gave more than 650,000 pounds to Britain's Conservative Party from 2001 to 2005 through his company Intercapital Private Group Ltd., according to the U.K. Electoral Commission.
Spencer was one of the first prominent donors to come out in support of David Cameron, a 40-year-old graduate of Eton and Oxford, in the battle for leadership of the Tories in 2005. After Cameron won, he asked Spencer to become co-chairman of the City Circle, a forum for the Tories to spread their message to the U.K.'s business community.
ICAP's Tory Forum
Spencer agreed and, during the past year, has hosted a series of lunches at ICAP's dining room to introduce George Osborne, the Tories' leader on Treasury issues, to movers and shakers in the City.
"He really spends time with people who come,'' says Richard Spring, a Tory MP and co-chairman of City Circle. "He's desperate to have the Conservative Party win -- aren't we all? He's very supportive of what Cameron is doing.''
Spencer, the Tories' deputy treasurer, has offered to throw the party a victory bash replete with cases of Chateau Petrus, one of the world's priciest wines, if they win the next general election, which must take place before 2010.
Current Prime Minister Tony Blair, in his 10th year in office, has said he will hand over power to Chancellor of the Exchequer Gordon Brown by September.
Spencer became an official member of the City establishment at the end of June last year, when ICAP joined the FTSE 100 Index of Britain's most valuable public companies. Spencer earned 5.7 million pounds in 2006, making him one of the highest-paid FTSE 100 executives.
Born in Kuala Lumpur
Born in Kuala Lumpur, Malaysia, toward the end of Britain's colonial rule there, Spencer later moved with his parents to Ethiopia and Sudan, where his father worked for an aid agency that later became part of the United Nations. At the age of 8, he was sent to Worth Abbey, a Roman Catholic boarding school in the south of England.
"I didn't like it very much,'' he says. "I really thought Africa was my home.''
He went on to study physics at Oxford University's Corpus Christi College, where contemporaries included Hector Sants, now managing director of wholesale and institutional markets at the Financial Services Authority, the U.K. regulator.
Spencer had already set his sights on working in the City while at Oxford, says Abbas Ourmazd, a fellow Corpus Christi physics graduate who is now vice chancellor for research and dean of the graduate school at the University of Wisconsin, Milwaukee.
"Even then, it was clear that was what he wanted to do,'' Ourmazd says. "I never got the impression that physics was his first love.''
False Start
After Oxford, Spencer went to work for Simon & Coates, a London broker that's now part of JPMorgan Chase & Co. In 1979, he shorted the price of gold, betting it would fall, only to see the price soar when the Soviet Union invaded Afghanistan later that year. Spencer lost 30,000 pounds on the bet, and his job.
He then moved to the London office of U.S. investment bank Drexel Burnham Lambert Inc., where in 1983 he lost $100,000 on a currency trade. Drexel, now defunct, fired him.
"He has proven to be a better entrepreneur than he was an employee,'' says his one-time boss, Richard Sandor, who was Drexel's New York-based senior vice president of financial futures. Sandor says he doesn't remember the circumstances of Spencer's departure. "I have the greatest admiration for him,'' says Sandor, who is now chairman of the Chicago Climate Exchange Inc.
Launching ICAP
After Drexel, Spencer landed at a small London brokerage called Charles Fulton, where he traded interest rate swaps, financial instruments that allow borrowers to exchange floating-rate payments for fixed ones and vice versa. Restless and eager for a challenge, in 1986 he scraped together 50,000 pounds to set up what was then called Intercapital, bringing a handful of brokers with him from Fulton.
"My early career was not conspicuously successful,'' Spencer says. "Having said that, if I'd had a slightly more conventional career, I never would have set up ICAP.''
At the time he started Intercapital, there were only about a half dozen banks trading interest rate swaps in London, says Darren Thake, who was a founding partner with Spencer and who left ICAP in the mid-1990s. "We were cash-flow positive from day one,'' Thake recalls. "We gambled a lot. Michael was always the bookrunner. It was a good source of team building.''
Swaps Take Off
What would later become ICAP opened up just as the interest rate swap market took off. Companies began using them extensively to protect against interest rate fluctuations. Outstanding interest rate swap contracts surged to $22.3 trillion in 1997 from $683 billion in 1987, according to the International Swaps and Derivatives Association.
Today, interest rate products, including swaps, are still Spencer's biggest money spinner. They generated 44 percent of ICAP's revenue in the six months to Sept. 30, 2006, with foreign exchange adding 13 percent.
In the early days, ICAP brokers were a small, tight-knit group known for staging zany events. For the firm's summer party in 1993, ICAP took over London's St. James's Square near Piccadilly Circus and decked it out in a Western theme, with ICAP brokers dressed up as cowboys and Indians, says Alex Hucklesby, a former ICAP employee who's now at interdealer broker Phoenix Partners Group in London.
At the end of that year, ICAP staffers all headed down to Leeds Castle in Kent, southeast of London, where they donned medieval garb for the ICAP Christmas photo, Hucklesby says.
Charity Day Shenanigans
The summer parties are gone. Brokers these days let loose only on ICAP's annual Charity Day, which last year took place on Dec. 7. ICAP employees drank beer and dressed up -- as knights in shining armor, as the Bee Gees, as Rod Stewart. The event raised a record 7.1 million pounds in donations.
ICAP employs a less rowdy bunch today, Spencer says. "It's a much more professional, serious, managed, disciplined, organized business than broking was 20 years ago,'' he says. And he says his own gambling days are over.
One symbol of the old days was hanging on the back of the chair of swaps broker Jonathan Gravestock in October: the Wanker Jacket. The frayed, brown, checkered garment has a large yellow W sewn on the back and used to be awarded every week to the employee who did something ridiculous or amusing.
One broker received the jacket about five years ago when he went home after a night of heavy drinking and found his house key wouldn't work -- because he had moved four months before.
ICAP killed the Wanker Jacket award about four years ago after ICAP executives began to worry that it might cause offense. "One day we realized that in its time it had its place, but the time had passed,'' Spencer says.
A Series of Acquisitions
Spencer has expanded ICAP through a series of acquisitions. ICAP bought a rival London broker called Exco Plc in 1998 and, in 1999, merged with London-based Garban Plc, a dealer strong in U.S. Treasuries and corporate bonds.
ICAP's growth has brought it head-to-head with Cantor over the years. The first clash came in 1993, when Cantor recruited 25 of ICAP's emerging-market-bond brokers, which prompted Spencer to sue Cantor for trying to persuade employees to break their contracts to join another firm, a violation of British law known as poaching.
In 1997, the U.K. High Court ordered Cantor to pay 815,000 pounds in damages to ICAP. The Court of Appeal later increased that to 1.1 million pounds. Then, in 1996, Cantor tried to lure away 11 options staffers from ICAP. Two brokers left, and ICAP persuaded the rest to stay, says Vogels.
I Poach, You Poach
Within months of the Sept. 11 terror bombing at the World Trade Center, Spencer began trying to hire three of Cantor's top London-based swaps brokers.
In 2002, after the brokers joined ICAP, Cantor filed another suit, which disclosed an Oct. 25, 2001, e-mail written by Spencer that read, "I would love to put one up their bottoms? this is the time I have been waiting for!!!'' In July 2003, Cantor and ICAP settled out of court for an undisclosed sum.
"It has been sadly a component of the interdealer marketplace that there have been fairly high-profile poaching battles,'' Spencer says now of the case.
In the latest lawsuit, Cantor sued ICAP in Delaware in 2003, alleging its BrokerTec and ETC electronic market systems infringed on one of ESpeed's patents. A jury in 2005 found that the ESpeed patent was invalid. After the jury's ruling, U.S. District Court Judge Kent A. Jordan ruled the patent was unenforceable. ESpeed is appealing.
Loss at ESpeed
Meanwhile, ESpeed reported a 2006 third-quarter net loss of $504,000, and as of Jan. 10, its stock price had declined 64 percent since January 2004.
ICAP faces stiffening competition from other directions. Rival voice broker Tullet Prebon has brought in some electronic trading of its own. In January 2006, it started TradeBlade to broker U.S. repurchase agreements, or repos, securities that dealers sell with a promise to buy them back at a specified time and price.
Since then, TradeBlade has put a dent in ICAP's control of the market. ICAP's market share in electronic repos is now down to 75 percent. TradeBlade has also started brokering U.S. Treasuries and agency debt. "TradeBlade could pose a threat,'' says Andrew Mitchell, an analyst at Fox-Pitt, Kelton Ltd. in London.
Still, ICAP continues to lead electronic trading in government and corporate debt and repos in the U.S. and Europe, says Dermot Doherty, European head of marketing for BrokerTec.
$150 Billion a Day
"These are all trades flying through as we speak,'' says Doherty, a 41-year-old native of Ireland, pointing to the BrokerTec screen, where numbers are flashing by in red. "We do about $150 billion a day in euro repos alone. The way we're going to expand is to bring new products on and encourage our clients to use it more.''
ICAP has struggled to make the leap to electronic trading in other areas. In 2004, it started iSwap, an electronic trading system. Spencer says the $250.8 trillion swap market should have gone electronic years ago. Still, most swaps continue to be bought and sold through voice brokers.
Opposition from that group may be one reason iSwap hasn't taken off, says Jan Kloosterboer, Amsterdam-based head of European swaps trading at ABN Amro Bank NV, which is a market maker on iSwap. "They're making a lot of money from voice broking, and they're trying to protect that a bit,'' Kloosterboer says.
Spencer says iSwap has failed because customers weren't ready for it, not because voice brokers have been resisting. ICAP employees are mostly behind him on the push to go electronic, he says.
Embracing Technology
"Brokers have embraced technology,'' he says. "They've realized if you try to resist technology, you will only be able to resist it temporarily, and you're doing your own career no service at all.''
The Chicago Mercantile Exchange is also betting that swaps have an electronic future. In July, it bought Swapstream, an electronic rival to iSwap, which enables interest rate swap trades to be done as a package linked to futures on Eurex AG, Europe's largest derivatives exchange.
Spencer isn't worried; he says Swapstream remains a small player. "We've always lived with competition,'' he says. "The exchanges generally have not lived with competition.''
Exchanges command fat margins compared with ICAP. The CME alone has an operating profit margin of 57 percent. The London Stock Exchange enjoys a 50 percent operating margin. In contrast, ICAP's margins are 26 percent in its electronic business and drop to 20 percent with voice broking in the mix.
LSE's healthy margins are what drew Spencer to the negotiating table this summer. Spencer says the two sides looked at whether they could plug the ICAP customer network into LSE's trading system to create a 24-hour stock exchange.
Project Turquoise
Spencer may be looking for an alternative to an LSE-ICAP merger. In November, seven major investment banks, including Citigroup Inc. and Goldman Sachs Group Inc., announced plans to start their own pan-European equity trading operation in 2007 to slash the price of trading shares.
Dubbed Project Turquoise, the undertaking is a direct grab at the LSE's trading volume. Spencer says ICAP has had discussions with the group, though the firm has no role in the project right now.
Exchanges should be worried, he says. "Their monopoly positions may well be challenged by some of the big customers setting up as competitors to them,'' Spencer says.
Rapid development of electronic trading systems is what makes all the market convergence possible. On the ICAP trading floor, Doherty, the BrokerTec executive, likes to point his fellow brokers to a quote he's taped to the top of his computer screen. It's from a speech Spencer made to the Bond Market Association in 2004: "I have in my mind's eye a vision of the future. It is electronic.''
While traditional voice brokers may not like the message, this is one bet that Spencer isn't likely to lose.
ICAP's Michael Spencer
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