Exchange buysider sees mergers among small venues

NEW YORK (Reuters) - Consolidation in the trading world will first sweep the smaller alternative venues, followed possibly by more among larger exchanges, the founder of a major exchange investment firm said on Wednesday.

Thomas Caldwell, chairman and chief executive of Caldwell Financial, added the proliferation of privately held alternative trading venues heightens the risk of price manipulation as the trading landscape fragments in the United States and elsewhere.

"Consolidation is the wave that you'll probably see and it will be in the ATS space," Caldwell said of so-called alternative trading systems, or ATSs, at the Reuters Exchanges and Trading Summit in New York.

"ATSs are more ripe for consolidation (than exchanges), and that would be over the next year to two years."

Mergers among major exchanges, which have seen their market share erode at the hands of ATSs, is on the more distant horizon, said Caldwell, whose Canadian firm runs an exchange-focused mutual fund and high net-worth trust.

"Everybody is looking around for dance partners here, but they haven't made a decision on who to do what with," the buysider said.

Technology-sharing deals are "almost better than mergers because you don't have to deal with cross-cultural barriers, regulatory barriers," he said. "The alliances for technology-sharing will be an ongoing trend for several years as everybody jockeys for position."

Toronto-based Caldwell Financial, with about C$1 billion ($852 million) in assets, owns stakes in NYSE Euronext (NYX.N), CME Group Inc (CME.O), TMX Group (X.TO), the Chicago Board Options Exchange and the Bombay Stock Exchange, among others, in its investment and asset management units.

The firm, which runs investment company Urbana Corp (URB.TO) and has a diverse investment base, has benefited as exchanges worldwide demutualized and listed their own shares. Caldwell said he expects technology development will be a main driver of industry growth in the years ahead.

There may be opportunities for exchanges to invest in ATSs that have superior technology, such as No. 4 U.S. stock trading venue BATS Exchange, he added.

But ATSs -- also called electronic communications networks (ECNs) in the United States and multilateral trading facilities (MTFs) in Europe -- are still only short-term players because they are privately owned, he said.

Broker-dealers have long developed so-called dark pools, alternative venues where they match buy and sell orders off-exchange in a process called internalization. There are roughly 30 dark venues in the United States.

Caldwell said this leads to "deeply flawed" pricing for market participants, and questioned whether other outsiders are on equal footing with banks when they trade in bank-owned venues.

"It now becomes open to manipulation. When you combine it with the internalization of orders, the potential for conflict is really quite exciting," he said.

"This is the next scandal to come: the combination of market fragmentation and internalization."

(For summit blog: blogs.reuters.com/summits/)

(Reporting by Jonathan Spicer, editing by Matthew Lewis)