Exchanges have traditionally relied on the revenue stream from execution spreads, however, with trading volumes declining (due, in part, to stagnant interest rates) and the new raft of regulation such as MiFiD, EMIR, Dodd-Frank entering the market, has the time come for exchanges to re-think their business models?
Over the past year, we have seen a frenzy of M&A activity where a number of the established exchanges have attempted to merge with, or bid for, other exchanges. The primary driver for exchanges seeking out mergers and acquisitions is to achieve economies of scale. However, given the recently failed merger between Deutsche Borse and NYSE Euronext, along with the LSE and TMX Group and Nasdaq and NYSE Euronext, exchanges will have to look again at their strategic options.
Beyond cost pressures, the traditional exchanges are also facing increasing competition from dark pools of liquidity1 and alternative trading platforms such as MTFs2 (for example, BATS Chi-X Europe and Turquoise3), hence they need to look beyond cost synergies and focus on diversifying their revenue streams. An example of this is LSE’s bid for LCH.Clearnet. If successful, this will allow LSE to expand their infrastructure to offer not only trade execution but also clearing facilities for their customers. Exchanges should be looking to invest in these alternative exchanges or become viable partners as a way of enhancing revenues and market share. We saw this with the investment made by LSE back in 2009 into the Turquoise platform.
Market participants are no longer just concerned with lower transaction costs (both execution and clearing) but also choice when deciding which platform to use for their transactions. Interoperability is increasingly viewed as the path to offering the market choice where in the long term, the benefits of the increased competition would be lower costs and higher level of service. We have started to see interoperability happening across exchanges, trading venues and clearing houses; one example is SIX x-clear Ltd (clearing arm of SIX Securities Services) which is already inter-operable with LSE, BATS and SIX Swiss Exchange. Interoperability with existing players in new markets is also seen as the engine to break into new rapidly growing areas such as Far East Asia.
Until the world economy stabilises, and interest rates start to rise, overall trading volumes will remain low. Amidst the intense competition, the winners will be those who can offer competitive pricing, diversified platforms and interoperability between the platforms. This is not the time to be complacent, this is the time for exchanges to evaluate their strategic options and adapt their business model to emerge as winners.
Notes
1. Dark pools of liquidity are trading venues that are away from the central exchanges and allow large institutional orders (known as block trades) to be filled and provide anonymity where the identities of buyers and sellers are not revealed.
2. MTFs - Multilateral Trading Facilities are trading venues that have similar structures to exchanges, though they do not have a listing process for companies wishing to list on the MTF. MTFs are deemed as alternative trading venues to the traditional exchanges such as LSE and NYSE.
3. Turquoise is an example of an MTF that was initially formed by a consortium of nine banks, which included BNP Paribas, Citi, Credit Suisse, Deutsche Bank, Goldman Sachs, Merrill Lynch, Morgan Stanley, Societe Generale and UBS.
Posted by Jaspal Dhillon and Minling Chen on the 13th of February 2012
