Mega-Exchanges and the Blur Factor

Russ Chrusciel, product manager – derivatives trading, SunGard Valdi

In the past few months, it’s clear that the trend of mega-exchange formation is already underway. Combinations include the London Stock Exchange and Toronto Stock Exchange, Singapore SGX’s bid for Australia’s ASX, BATS Global Markets’ merger with Chi-X Europe, and last but certainly most controversial – the Deutsche Borse and NYSE Euronext.

As the financial landscape continues to evolve, most existing exchanges will not stand pat, but will seek logical partners to both expand their product offerings and to remain relevant to the trading community on a global scale. But as we settle in to watch this trend unfold, it’s important to see through the flurry of high-level media coverage.

Don’t get me wrong, the rise of the mega-exchange could be a boon to securities firms that use any kind of exchange services! The consolidated exchanges to come will certainly streamline their business processes and IT infrastructures – which will likely result in these mega-exchanges being able to offer lower fees to their customers (largely taking advantage of economies of scale, almost what I’d term the Wal-Mart effect).

Yet the most recent coverage of the Deutsche Börse’s takeover of NYSE Euronext missed a subtle point that I think deserves more attention. For lack of a better term, I’ll call it the “blur factor.”

Assuming the Deutsche Borse – NYSE merger comes to fruition (unless Nasdaq finally enters the fray with a bid real soon), the consolidation of these two major entities will herald a new age of mega-exchanges – one that will progressively redefine what it means to be a “listed exchange” in our modern financial world. This new breed of exchange is a far cry from the origins of the NYSE back in 1792 – when stock brokers signed an agreement under a buttonwood tree on Wall Street to transact simple business with each other. Contrast that event to the present in 2011, where these burgeoning mega-exchanges have uniquely evolved into large technology organizations that not only bring together a variety of market participants, but also have expanded their reach into software, hardware and other services.

So what drives and differentiates exchanges today? I’d argue that more and more, the differentiator has largely become – in some shape or form – technology. Most exchanges would acknowledge the fact that business relationships are certainly important to conducting business in the financial industry (or any industry for that matter!). However, over the past few years, one could also argue that technological advances have become even MORE valuable to exchanges or selected groups in the trading environment. Not too long ago, common financial market buzzwords were terms like “trading pit”, “stamping tickets” or “payment for order flow” – terms that reinforced more of the human side of trading and exchange activity. But what descriptive words do we now use more and more when talking about exchanges and trading? Terms like “latency”, “co-location”, “microseconds” and “matching engines”.

Going forward, the relevance and profitability of global exchanges will not be determined solely by bringing buyers and sellers together in one common location to trade. Rather, each exchange will ultimately succeed or fail based on its ability to offer a compelling mix of varied trading products combined with a valuable set of complementary technology offerings. Quite simply, exchanges will need to provide its customers a full suite of products across many asset classes (like equities, options, futures) while simultaneously offering even greater access to exchange infrastructure, hosting facilities, server farms, market data and the like.

So will these mega-exchanges be able to perform well in their dual roles of marketplace and service provider? And what will this shift mean for other participants in the financial industry? Rest assured, even though mega-exchanges will seek to expand their large “footprint” into new markets and related services, there will also be nimble competitors of miscellaneous sizes who will ultimately seek to gain leverage by simply focusing on smaller niches within the larger financial industry.

I can guarantee that it won’t be dull. However, only time will clear up this “blur factor”.