Under pressure, exchanges moving out of element

Adena Friedman, CFO of the Nasdaq OMX, speaks at the Reuters Exchanges and Trading Summit in New York March 31, 2010.

NEW YORK (Reuters) - With the vice tightening on the home turfs of top exchanges, they appear brave-faced in betting that at least some ventures outside their comfort zones will provide relief in the post-crisis world.

Pending regulatory change was on the tips of most executives' tongues at the Reuters Global Exchanges and Trading Summit this week. For all the pressure the accompanying uncertainty adds to an already cutthroat industry, they seemed sure that nimble -- if not guaranteed -- strategies would pay off.

"Competition will continue to enter into a lot of different markets where there might be only one player today, so the barriers to entry are low in some respects," said Adena Friedman, Nasdaq OMX Group Inc's (NDAQ.O) chief financial officer.

"But at the same time that also gives you opportunity."

The exchange industry, having digested the blockbuster mergers of three years ago, is squeezed on several fronts by dealers pushing trading costs down, market rules that encourage upstart venues, and an uncertain environment that's keeping volumes low and forestalling a second wave of consolidation.

Still, positive signs are clear.

Regulators are increasingly backing established exchanges and touting their transparency; the exchanges themselves are maneuvering to benefit from high-speed trading and the hunger for data; and the exchanges are aggressively pursuing smaller investments in long-shot ventures, increasingly -- and perhaps ironically -- aligning their interests with those of dealers.

"You can own 100 percent of something that grows at a low rate or you can own 50 percent of something that you think is going to grow at a faster rate," said Larry Leibowitz, chief operating officer at NYSE Euronext (NYX.N), which recently sold stakes to dealers and others in one of its options exchanges and a new futures exchange.

"Organic growth is very difficult. As an exchange complex, each of these is one piece of the puzzle, and that's why you build multiple markets ... in different asset classes and geographies," he said. "You hope that, in the end, you create something that is bigger and gets you there faster."

THE SQUEEZE AT HOME

Stock markets in Canada, Australia and elsewhere are edging down the trail blazed by the United States and Europe, where new rules in the last decade paved the way for privately run trading venues to proliferate and take on incumbent exchanges.

The dealers and other big trading firms backing these venues sparked a one-way pricing war that sharply narrowed exchanges' profit margins, and forced them to buy or build their way into derivatives, and new regions and technologies.

William O'Brien, CEO of trading venue Direct Edge, noted the "lemming-like mentality" of exchanges crowding into new arenas. "There are certain areas where you have a proliferation of new competitors all pursuing effectively a similar business model, and all struggling to ... achieve profitability."

Perhaps ominously for U.S. stock exchanges, O'Brien added: "A whole new phase of competition and innovation is about to begin in this industry." Direct Edge is backed by Goldman Sachs Group Inc (GS.N), JPMorgan Chase & Co (JPM.N), and others.

Adding to exchanges' headache, trading volumes on capital markets -- the lifeblood of core exchange revenues -- have dropped sharply from last year's records. "It's definitely not fun," NYSE's Leibowitz said of the recent U.S. drop-off.

THE VENTURES ELSEWHERE

The exchanges, having bled market share at home over the last few years, have seized on what could be timely regulatory reviews of market structure on both sides of the Atlantic. They want a tightening of what they call lax rules for upstarts.

"What we want is addressed clearly. Are exchanges going to be treated the same or not, because today they are not," said Xavier Rolet, the London Stock Exchange Group Plc (LSE.L) chief.

"We need to say we actually do appreciate what exchanges provide, which is resiliency, quality and transparency."

Transparency is the rallying cry of lawmakers aiming to revamp the world's vast over-the-counter market, seen as a cause of the 2008-2009 financial crisis. They want to run more products through exchanges and clearinghouses, which are often run by exchanges, presenting a tantalizing new opportunity.

Deutsche Boerse AG (DB1Gn.DE), Nasdaq OMX, and NYSE Euronext, as well as futures exchanges IntercontinentalExchange Inc (ICE.N) and CME Group Inc (CME.O) have either recently launched or plan to soon launch clearing for OTC products.

Some, like NYSE Euronext's Europe credit default swaps plan, have failed while others, such as ICE's U.S. CDS plan, have succeeded.

Meanwhile, the growth of high-speed electronic trading has given exchanges new revenue from data distribution and the rental of space next to their trading systems.

Harold Bradley, who oversees nearly $2 billion in assets as chief investment officer at Kauffman Foundation, pointed to NYSE Euronext's construction of two centralized data centers. "That's interesting," he said, "and potentially brilliant."

(Reporting by Jonathan Spicer, additional reporting by the Reuters London bureau, editing by Gerald E. McCormick)