NYX Nyse Euronext

Shares of financial-exchange operators took a beating Thursday, after an Obama administration proposal to curtail banks' proprietary investing sparked worries of a broader slowdown in U.S. trading.

President Barack Obama on Thursday outlined a plan to prevent commercial banks and institutions from operating and investing in hedge funds, while capping trading activity done for in-house accounts, in a bid to reduce the risk such firms pose to the economy.

While Wall Street banks aren't the largest users of exchanges by volume, cutting their order flow could reduce liquidity and trading opportunities for others in the market.

"The feeling is that if banks' proprietary trading is going to be curtailed, that will impact others, like high-frequency trading firms, that trade on the back of that order flow," said Mark Lane, an analyst with William Blair & Co.

CME Group Inc. (CME), the Chicago-based futures-market operator, was the worst-hit in Thursday's stock-market decline. Analysts estimate it derives approximately 14% of its trading volume from banks' proprietary trading. CME shares fell $19, or 5.8%, to $310.96 in late afternoon trade.

New York-based NYSE Euronext (NYX) and Nasdaq OMX Group Inc. (NDAQ) fell 3.9% and 4.8%, respectively, closing at $24.63 and $18.97 respectively.

IntercontinentalExchange Inc. (ICE), an Atlanta-based operator focused on energy and credit markets, saw its shares slide 3.8% to close $4.08 lower at $103.56.

Officials for NYSE Euronext, Nasdaq OMX, CME and ICE declined to comment on the proposal.

While the Obama administration sought to ensure banks serve customers first and their own accounts second, average investors could be hit anyway if market liquidity is damaged, according to Gary DeWaal, general counsel for futures brokerage Newedge.

"Reduced liquidity tends to result in less efficient prices, and that's not a good thing," DeWaal said.

Both DeWaal and Lane stressed that with no detailed plans revealed so far, much could change in what is expected to be a drawn-out legislative process.

"I think the market's overreacting a little bit--it's a scary headline," said Lane, adding that investors may be taking too broad a view of what constitutes banks' proprietary trading.

Donald Fandetti, a senior analyst with Citi Investment Research, said the market's reaction to the proposal represents a buying opportunity in exchange stocks, particularly those focused on derivatives.

In a note to clients Thursday, Fandetti wrote that proprietary trades from banks fall into several different categories, and the true proprietary trading targeted by the Obama administration represents only 4% to 5% of total volume at CME.

ICE is more heavily weighted toward commercial-market participants like airlines seeking to hedge energy risk, Fandetti wrote, while it could capture some trade at its London-based platform.

"CME and ICE have seen their shares hit from other unexpected events such as the CFTC's energy derivative position limit announcement and their shares ultimately recovered," Fandetti wrote.

DeWaal noted that the Obama proposal endorses Newedge's model--a business focused entirely on customer trading--that he said has gained traction amid banks' struggles over the past year.

However, he said that customers ought to have the choice.

"Customers are aware of the issues that are out there, and they can choose to engage in firms that do proprietary trading and other activities, because they have value," DeWaal said.

-By Jacob Bunge, Dow Jones Newswires; (312) 750 4117; jacob.bunge@dowjones.com

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