Each to Their Own Design: A New Direction for Exchanges
Liquidnet’s Seth Merrin shares how exchanges can develop a global strategy to compete today.
Following a year of failed crossborder mergers, exchanges are at a crossroads. They have worked in siloes within their respective countries but now have to create their global strategies. To move forward, there are lessons for the exchanges to learn from another industry that followed a very similar trajectory more than a decade ago—the airline industry.
Airlines share many parallels with exchanges—a strong nationalistic sentiment, a highly competitive environment driven by the entrance of low cost carriers, and a record of unsuccessful M&A activity. So what steps did the winners in the airline industry take in order to beat out the low cost competition, how did they achieve global scale and what can exchanges learn from this?
Airlines tackled the fundamental evolution of their industry by focusing on three key areas: diversification of revenue by selling more to their existing client base, differentiation of their offering by focusing on a premium customer, and development of global alliances to expand their geographic reach.
Let’s first take a look at revenue diversification and how exchanges can take a similar approach. Airlines realised they had a captive audience with their customers and once they had these customers in their seats, they could sell them more products. As a result, the airlines introduced paid-for services in coach and new premium products and services to all customers. Who hasn’t been on an aeroplane and paid for food, extra space, or, picked up an ever-expanding catalogue of duty free items?
Historically, exchanges have had two primary streams of revenue: company listings and trading. Today, these revenue streams constitute only a minor component of total revenue as exchanges have placed more emphasis on their ‘premium offerings’. The NYSE Euronext and Nasdaq, both of which have faced significant competition sooner than many of their peers, recognised that they had a captive audience in their listed companies and expanded their offering by selling premium services such as new technology offerings and premium data products and services. Today, both of these exchanges have multiple revenue streams and no single business comprises more than 20% of their overall revenue. What they have left to do—and what virtually no other exchange has done—is to develop a premium class of customer.
The entrance of low-cost providers, such as EasyJet and Ryanair, in the airline industry commoditised the price of an airline seat. As a consequence, airlines (particularly the established players) could no longer compete on price alone and needed to diversify their offering. So they went upscale, choosing instead to focus on high margins and higher value offerings, which their discount counterparts couldn’t match. While discount carriers charged for pillows, winning airlines created a premium offering and experience for their business and first class travellers. It’s not surprising that these premium passengers were willing to pay significantly more for steak, champagne, and lieflat beds because of the ultimate experience these airlines provided.
As exchanges have demutualized, they have focused primarily on high frequency trading and non-trading services, two low margin, commoditised offerings—the economy end of the plane if you will. By focusing on these types of services, exchanges have missed a significant opportunity to differentiate themselves through building a first class cabin for an underserved constituency—the institutional investor.
Institutional investors need a safe and efficient way to trade in size. Exchanges are well positioned to help facilitate a new market structure where these institutions can trade alongside the retail market—choosing when they would like to interact with other constituents and be protected when they do not. Across the world we have seen that a single execution venue cannot efficiently handle all the competing interests in today’s marketplace. By catering to the needs of institutions, exchanges will benefit with increased execution sizes, increased liquidity and a more efficient market where they can attract greater investment to their country from around the globe.
What we can learn most from the airline industry is how they embraced a global strategy that did not rely on consolidation. Airlines realised that it was not realistic to consolidate airlines to create their global reach. Their solution was to create global alliances through code and service sharing agreements which would allow customers to travel around the world with one ticket, and without re-checking their luggage.
It is equally unrealistic to think that exchanges could acquire enough exchanges to create a similarly global reach considering the scale of a global platform, the politics and the nationalist pride that would accompany any acquisition of an exchange by a foreign entity. The majority of recent merger talks have all but been abandoned due to issues such as these.
The age of going global through exchange consolidation is dead. Exchanges need to rethink how they can create global scale for their members to access the best opportunities regardless of where they are in the world. Exchanges, long the centre of capital creation in their local markets, are well positioned to become the gateway to the rest of the world by creating borderless trading opportunities that benefit all of their constituents. Through global alliances, exchanges have an opportunity and a better alternative for facilitating investment in and out of their countries and serving the global investment needs of institutional investors—without compromising their important role at home.
This is already happening. Since the launch of Liquidnet’s partnership with the SIX-Swiss Exchange last year, it has quickly become the largest exchange operated dark pool in Swiss equities, with turnover topping CHF1.36 billion, and with an average trade size of CHF708,136—more than 96 times larger than any other MTF or exchange (dark or lit) as of the first quarter 2012. SIXSwiss Exchange members can now direct executable block orders in 2,500 Swiss and other European names to the platform.
Exchanges, despite being a pillar of their local economic and market structures, must find new ways of diversifying, differentiating and developing a global strategy in order to compete in today’s highly evolved market dynamic. Partnerships, like the airline industry’s code-sharing, offer attractive ways of doing this without raising nationalistic or political concerns at home. Above all, they offer exchanges the opportunity to best serve a premium client—the institutional investor—a client that represents the millions of investment and pension holders in their market.