Competition picks up between brokers and exchanges
NEW YORK (Reuters) - A once cozy relationship between exchanges and broker-dealers has cooled as investment firms develop new trading platforms and square off against the markets they relied on for decades.
Tensions have risen as a number of leading exchanges transform from private organizations accountable to seatholders to public companies with investors to please.
"Broker-dealers were accustomed to viewing exchanges as utilities and now we're seeing some growing pains," said Keefe, Bruyette & Woods analyst Richard Herr. "There is a new profit motive at the exchanges and for the next couple of years there will be this pushing and pulling."
Public exchanges had a busy 2006, with blockbuster deals such as the $14 billion merger between NYSE Group (NYX.N) and Paris-based Euronext ENXT.PA, an options platform planned by the Nasdaq Stock Market (NDAQ.O), and price changes such as the New York Stock Exchange's elimination of a monthly fee cap for member firms.
"NYSE's fee change significantly increased trading costs for the largest six to eight brokers," Herr said. "The fee cap was a vestige of the exchanges being a utility."
Broker-dealers have also been active, investing in regional exchanges and alternative trading systems, or ATSs, that may circumvent public exchanges.
One high-profile ATS is Block Interest Discovery Service (BIDS), which is backed by investment banks Citigroup (C.N), Goldman Sachs (GS.N), Lehman Brothers LEH.N, Merrill Lynch MER.N, Morgan Stanley (MS.N) and UBS (UBSN.VX).
"Broker-dealers are involved in my business because the exchanges changed their form and became for-profit, multi-asset class and multinational organizations," said Timothy Mahoney, Chief Executive of BIDS.
SQUEEZING EQUITIES
Exacerbating the emerging tension is pressure on commissions received by broker-dealers, who can be squeezed by growing competition, client scrutiny and increasing costs.
"What is clear from overall industry numbers is that the core business of institutional equities - executing trades, providing research and advisory services and restructuring portfolios - is not beating its cost of equity capital," wrote Sanford Bernstein analyst Brad Hintz in a note last May.
BATS Trading, another broker-dealer backed ATS, could ease things for some brokerages. It has been pitching an aggressive fee schedule and says it recently handled about 10 percent of Nasdaq-listed volume.
As a private dealer-owned company, BATS follows a model abandoned by NYSE and Nasdaq when they transformed into institution-owned, shareholder-driven public companies, BATS Chief Executive Dave Cummings said.
"The big question is whether publicly held exchanges are in the dealers' interests," he added. "It's pretty clear the broker-dealers weren't too happy with the market structure they saw 18 months ago. I think they are a lot happier with what they're seeing now."
Regional exchanges, typically small and private, have also benefited from broker-dealers like Citigroup, an investor in the Philadelphia and Boston Stock Exchange. Continued...
