Summary Most analysts view futures exchanges models to be the most attractive, followed by options exchanges, with equity
or other spot/cash market venues generally being the least valuable (In the US, margins are very tight owing to years of intense pricing pressure, and in Europe, trends are following closely in the USs footsteps.). To build market share: As per broker reports, given the fact that exchanges essentially have come to a bottom in terms of pricing competition in equities, the primary way for new venues to gain traction is to offer differentiated trading rules that appeal to different trading niches. E.g. NASDAQ has had strong success building market share in US options over the past two years. The company has grown the PHLX from 14% share at the time of its acquisition to a 23%-24% share. This was achieved primarily through a transition of the venues pricing structure from pure customer priority to a hybrid customer priority with maker/taker aspects and migration onto NASDAQs technologically superior trading platform. Additionally, if there are rule changes on dark pool trading, that could potentially benefit the exchanges in the future. Following table gives a break up of revenue for the leading exchanges by the business lines that these exchanges operate in. It can be seen that NYSE, DB, LSE, and NDAQ are highly diversified in terms of sources of revenue generation. Also, cash equity trading/clearing is only a small part of the overall revenue for NYSE and NASDAQ. NYSE generates around a quarter of its revenue from Futures trading whereas NASDAQ generates a higher percentage of revenue from Options trading and data products.
Risks: Competition: Following the transition of broker-owned exchanges to for-profit companies, the industry has experienced a rise in competition across all lines of business. The U.S. was the first to encourage privately owned execution platforms to compete with exchanges, which led to the launch of dozens of electronic communication networks (ECNs) and alternative trading systems (ATSs). The impact on traditional exchanges was pronounced, with severe declines in market share and net price capture per matched trade as illustrated by charts below:
Across the Atlantic, Europe continued this trend by passing the Markets in Financial Instruments Directive (MiFID) in 2007 that served to integrate various Euro markets and enhance competition among market operators. New entrants have enjoyed several advantages, the most prominent of which is much lower overhead that has allowed for extremely competitive pricing. While it may be argued that current pricing is unsustainable in the long term, exchanges have been forced to adjust internal pricing strategies to limit already material share losses during the past decade. Equity options trading has faced a different set of market dynamics as its structure has been competitive for some time in the U.S., but this product continues to respond to changing customer demands for technology, pricing, and order flexibility. Derivatives trading has been the slowest product group to respond to competition due to the natural barrier to entry via vertically-integrated clearinghouses. Pricing: As per analyst reports, competitive pressure in the US equity space has eased. Average pricing has reached a trough and has actually rebounded somewhat, and market share, at least among the lit venues, has stabilized. The wild card with respect to US cash markets, however, is the interplay between the off-exchange venues (broker internal crossing and dark pools) and the lit markets like NASDAQ. TRF share (off-exchange transactions reported to the Trade Reporting Facility) has increased from roughly 15% in early 2008 to upwards of 30% presently, and it is this dynamic more so than market share gains at competing lit venues like BATS or Direct Edge that has pressured the market share of Nasdaq and NYSE lower.
Transaction-based business: Exchanges earn a large part of their revenues from transaction-oriented fees, which are dependent on industry trading volumes. Factor including (a) depressed markets, (b) tightening capital requirements, (c) decreased credit availability, (d) outflows of client funds, (e) trend towards passive investing, and (f) general investor malaise affect the transaction volumes leading to lower revenues for exchanges. Regulatory changes: Exchanges remain exposed to some negative developments in terms of regulations, the most prominent of which include transaction taxes or position limits. Both of these items have been discussed by U.S. and European governments and regulators
BMO Capital Markets broker report regards the earnings risk as muted for position limits, which are likely to be mostly benign, and transaction taxes, which appear unlikely to receive approval and are generally regarded as harmful to a broader set of constituents than the financial industry itself.
