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A Brighter Outlook for Stock Exchanges?

Increased competition and technology innovations could help rekindle exchanges’ entrepreneurial fire.

Securities markets go in cycles. For stock investors, this has been an up year.

At the same time, the business of operating the markets on which securities trade goes through cycles of its own, and the current one isn’t looking so good. With daily share volumes well below historical peaks, consolidation rules the day. The upstart IntercontinentalExchange is nearing completion of its acquisition of NYSE Euronext, parent of the venerable New York Stock Exchange. BATS Global Markets and Direct Edge Holdings, the fourth- and third-largest U.S. exchange companies, respectively, expect to consummate their recently announced merger in the first half of 2014.

These organizations also find themselves in the regulatory glare after a series of systems crashes that have besmirched their brand names.

By outward appearances, the environment contrasts starkly with that of the late 1990s, when a technology-fueled boom in stocks coincided with an explosion of electronic trading platforms and related capital markets innovations that investors and regulators alike eagerly embraced.

In the shadow of megamergers and profit pressures, securities industry competitiveness and innovation seem deemphasized or even dormant, with no trace of the dot-com years’ heady exuberance. But that would be an oversimplification — and an unfair judgment of the financial industry’s creativity and competitive drive.

Douglas Atkin, CEO of electronic trading pioneer Instinet Group from 1998 to 2002, witnessed and contributed to that era’s harmonic convergence. Instinet went public in 2001, and its legacy endures in such places as Nasdaq OMX Group, which acquired its Inet trading platform; in Chi-X Europe (now part of BATS) and the other Chi-X Global exchanges, which Instinet started; and in the execution services of its current parent, Japan’s Nomura Group.

Today, Atkin manages venture capital investments at Guggenheim Partners in New York and perceives a changed world. “We look at different business models,” he says. “We see proposals for exchanges and dark pools. Most do not have a shot at success.”

Instinet and other new-wave trading venues thrived when established exchanges were mutually owned and less aggressive than they are today as public companies, adding asset classes and pursuing growth globally.

Still, someone with a new idea “can develop liquidity, and it will work well,” Atkin explains. These days, however, he sees “more flameouts than success stories.” And yet a constant stream of proposals passes in front of Atkin and other potential funders. Some will break through.

This is as it always has been — a continuous, if cyclical, churn of product or process innovation and technology development. Longtime securities market analyst Larry Tabb, CEO of Tabb Group, calls it an accordion effect. Exchanges get big and take advantage of their dominance to raise prices. That creates openings for new entrants to take on the incumbents, which might in turn reprice, retrench or refocus their energies. The pattern eventually repeats.

In the U.S. the number of dark pools and other alternative trading systems is not shrinking: 92 were registered with the Securities and Exchange Commission as of August 1, a net gain of two since March.

On the pan-European scene BATS Chi-X Europe’s success is attracting new aspirants. London-based Aquis Exchange, for instance, led by former Chi-X Europe chief executive Alasdair Haynes, aims to disrupt what it terms the duopoly of BATS and the London Stock Exchange Group. Aquis has gained financial backing from the Warsaw Stock Exchange and has mapped a technology sales strategy to rival the likes of LSEG, Nasdaq OMX and NYSE Technologies.

Regulatory changes make derivatives especially ripe for trading and technology innovations. Another London start-up, Global Markets Exchange Group, launched in August and announced an interest-rate-swap futures product in September. With former Chi-X Europe COO Hirander Misra as chief executive, GMEX has a multi-asset-class blueprint and indexing and technology units on its organization chart.

Competition is also brewing in Brazil, where BATS–Direct Edge and a joint venture of Americas Trading Group and NYSE Euronext have the multiasset incumbent BM&FBovespa in their sights. In Canada, Aequitas Innovations, a consortium of leading financial institutions, seeks to challenge the TMX Group.

An entrepreneurial mentality still prevails, even when the odds may be long. As Atkin describes it: “There is a lot of gold in the hills. If you get it right, you can be extremely profitable.” • •

Jeffrey Kutler is editor-in-chief of Risk Professional magazine, published by the Global Association of Risk Professionals.

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