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What’s Exchanged?

Lou Pastina, Managing Member at Global Markets Advisory Group

Lou Pastina, Managing Member at Global Markets Advisory Group

The pattern has been repeated in many industries. A few large players develop monopolistic tendencies, and customers complain. The answer by government is to create competition, so rules are loosened to allow new entrants into the market. Rules that protected the monopolies are watered down; leaks and cracks appear in the ramparts, and suddenly those large players are fighting for their lives as they previously knew them.

The introduction of new technologies is usually a driver in the changes that follow. Market share is redistributed. The entrenched must change or die. The entrepreneurial upstarts are laser-focused on upending the status quo. However, it never really turns out how you think it will. Think about the airline business for example. Large airlines dominated the scene, encouraged by government because the only way to get an entire industry off the ground is to provide monopolistic like support to capitalize the infrastructure needed to introduce something as life changing as air-travel. But as decades go by and people are used to flying, it becomes apparent that newer technologies are not being integrated and customer service declines, and prices increase. So, the government introduces new players who fly smaller, faster planes at cheaper prices. Some large players don’t know how to change and go out of business. Others simply buy the upstarts and integrate them into their older operations providing a quick way to freshen up their offerings.

And so, when stock exchanges started to ignore the requests of its best customers and members, the same story enfolded. Alternative Trading Systems morphed into newer, tech-savvy- Exchanges and challenged the dominant players in the industry. Not surprisingly those upstarts were bought out by the more established Exchanges and the industry was refreshed with newer technology, an updated infrastructure, and newer, younger management teams more responsive to their customers.

But like the airline industry the old monopolistic tendencies sometimes creep back into the operating protocols of Exchanges. This is certainly true regarding the ongoing debate over the cost of market data. In addition, listings are still a duopoly, with little competition to speak of.

So, what happened to the upstarts? Well let’s take a look. The NYSE operates five stock exchanges: the former American Stock Exchange, Chicago Stock Exchange: National Stock Exchange; Archipelago (itself the former Pacific Stock Exchange) and of course the New York Stock Exchange.

The Nasdaq acquired the Boston Stock Exchange, Island/Instinet/Brut, Philadelphia Stock Exchange, and of course their own, the Nasdaq.

The Cboe recently acquired the Bats exchanges which included two of their own plus the two Direct Edge Exchanges.

The only independent Exchange in operation is the IEX Exchange, although the LTSE was recently approved, but not operational yet.

That means that after a period of confusing but innovating technological and regulatory driven changes that saw many entrepreneurial upstarts come on the scene, the former dominating Exchanges are even more dominating today. The count as of exchanges owned by the major players stands at NYSE (5); Nasdaq (3); and Cboe (4).

Why do they have to own multiple licenses? Well it becomes a game of pricing really. Each offer a complicated set of pricing for trading on their markets. Some charge to take liquidity, some charge to post liquidity. One charges for both. They mostly all charge for market data, the end product of their “factories”. And only two really charge fees to the corporate community for listing and to provide a secondary market for trading of their securities.

Is all that necessary? Probably not. They are competing with each other, and maybe that stirs some continued innovation, or competitive pricing, but that is debatable. What is not debatable is that the pattern has continued. Monopoly to establish an industry; governmental intervention to spark change; chaotic scrambles to buy and be bought; consolidation reversion back to the mean.

If one thing is for sure, it is that every ten to fifteen years there will be change. But rest assured in that change, everything will be as it once was, you simply have to wait long enough.