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Private exchanges looking to turn back clock
May 15, 2009 / 7:55 PM / 9 years ago

Private exchanges looking to turn back clock

By Jonathan Spicer - Analysis

NEW YORK (Reuters) - A new era in stock exchanges may be on the horizon -- and it looks something like the past, when a small handful of owners ran important capital markets.

Privately owned U.S. trading venues Direct Edge and BATS Exchange command nearly a quarter of all U.S. stock trading and have no intention of leaving, shaking a field long dominated by the New York Stock Exchange and Nasdaq Stock Market.

The two publicly owned incumbents have traditionally bought any upstarts in order to tighten their grip on the market. But that’s no longer an option because the upstarts’ owners are also largely their customers, and could simply shift their business to new venues elsewhere.

While the incumbents’ parents, NYSE Euronext NYX.N and Nasdaq OMX (NDAQ.O), have responded with transatlantic mergers and new business models, the smaller challengers -- which sprouted in the last few years and bloomed through the market selloff -- are either transforming into formal exchanges or planting seeds overseas.

Executives at the Reuters Exchanges and Trading Summit this week raised the specter of a partial return to a system in which key marketplaces are run by a small group of powerful players.

”Exchanges used to be mutual organizations that were run for the benefit of the members,“ said BATS Chief Executive Joe Ratterman. ”Well, that’s what we’ve created here -- an exchange that runs for the benefit of the representative user group. And so I think it can last indefinitely.

“Our interests are now aligned with the Street, wholeheartedly,” he said.

Aggressive market deregulation in the United States brought an explosion in alternative venues, known as electronic communications networks, or ECNs, in the last decade, setting the tone for changes elsewhere.

Europe, and then other parts of the Americas and Asia, followed suit in the last few years as waves of private alternative venues sparked competition with incumbents such as Deutsche Boerse (DB1Gn.DE), the London Stock Exchange (LSE.L) and TMX Group’s (X.TO) Toronto Stock Exchange.

Direct Edge, whose platform was launched in late 2005, accounted for 12.5 percent of U.S. matched market share in April, compared to 10 percent at BATS, which began operations in early 2006. Direct Edge’s market share has more than tripled in less than a year, while BATS has edged up after a strong first two years in operation.


New Jersey-based Direct Edge, which aims to be a formal exchange later this year, is owned by Goldman Sachs (GS.N), Knight Capital Group Inc (NITE.O), hedge fund giant Citadel, and options mart International Securities Exchange.

Kansas City-based BATS, which is already in Europe and is now eyeing options markets, is owned by several big investment banks including Citigroup (C.N), Credit Suisse Group CSGN.VX, JPMorgan Chase & Co (JPM.N), Morgan Stanley (MS.N) and Deutsche Bank AG (DBKGn.DE).

“What that exchange then looks like is what I would call a ‘semi-mutualized exchange,'” said Duncan Niederauer, CEO of NYSE Euronext, which has more than 30 percent market share.

“It starts to look like the old NYSE member-ownership model, which I think we all concluded was not a great outcome and actually was fraught with conflict.”

The NYSE traces its roots to an agreement among brokers in the late 1700s, and in 2006 moved from a seatholder- to a shareholder-owned company. The National Association of Securities Dealers founded NASDAQ in the 1970s but divested itself in 2001, allowing the company to later go public.

NYSE Euronext and Nasdaq OMX, whose market share slid toward 20 percent in April, each derive less than 15 percent of overall revenues from U.S. equities, and have remained profitable since going public.

Direct Edge and BATS say they, too, have turned profits since late 2007. As exchanges, the private firms could also tap new revenues from market data and even listings -- which Niederauer said could raise regulatory eyebrows.

“I think the SEC will ultimately re-look at some of these regulations,” he said of dealers funneling orders to their exchange arms.

But Direct Edge CEO William O‘Brien said he is “not at all” worried about new regulatory requirements as it becomes an exchange, and later, possibly looks to list its shares.

“This level of competition is here to stay given the health of the four competitors you see before you,” O‘Brien said. “We’re a profitable company so it’s sustainable for us.”

U.S. equity trading volumes have continued to swell throughout the mortgage market-inspired selloff, sustaining trading revenues for the four players despite a bruising price war aimed at attracting high-frequency traders.

“We are talking about a market that will continue to grow ... and there will always be niche players,” Nasdaq OMX President Magnus Bocker said.

“We assume there will always be competitors, whether the owners will be brokers for a certain period of time.”

(For summit blog:

Reporting by Jonathan Spicer; Editing by Richard Chang

Our Standards:The Thomson Reuters Trust Principles.
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