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Exchanges Go Beyond Trade Matching

Markets Media

Taking market-share losses from a multi-year siege on their main front, global exchanges are not just crouching down and defending themselves — they also are responding by going on the offensive and opening up new fronts.

The main front is trade matching, a business that has opened up to competition over the past decade, allowing alternative trading systems and other upstarts to siphon off order flow. The new fronts are technology-related, as exchanges are increasingly horning in on the territory of firms that provide connectivity services, co-location, consulting and data management.

The diversification of exchanges’ revenue comes in the wake of a broader evolution of exchanges, from utilitarian and monopolistic (or duopolistic) trade matchers, to publicly traded entities.

“Experience in using the technology that exchanges have is excellent experience for being in the tech business, and the whole reorientation from a neutral to a for-profit organization fits right into that,” said Robert Schwartz, a finance professor at Baruch College in New York. “You wouldn’t expect a neutral organization to be operating in this fashion, but when you’re a for-profit it makes sense to offer a suite of services.”

The poster child for exchanges diversifying revenue is NYSE Euronext, which generated $318 million in technology-services revenue in 2010, 145% more than the $130 million reported in 2007. NYSE Euronext’s overall revenue rose to $4.43 billion from $3.94 billion over the same period, an increase of 12.4%, or less than one-tenth the expansion rate of tech revenue.

A key event in NYSE Euronext’s tech build-out was its $200 million purchase of Wombat Financial Software in 2008. “Wombat bridges our commercial technology and market data strategies, broadening our customer reach and enabling NYSE Euronext to deliver advanced technology solutions to our customers’ increasing data management challenges,” NYSE Euronext Chief Executive Duncan Niederauer said when the Wombat deal was announced in January 2008.

NYSE Euronext has more recently said it aims to increase revenue at its NYSE Technologies unit to $1 billion by 2015, or about triple current levels.
In a regulatory filing, NYSE Euronext said it generates technology revenue “primarily from connectivity services related to the SFTI and FIX networks, software licenses and maintenance fees and strategic consulting services…We also generate revenues from software license contracts and maintenance agreements. We provide software which allows customers to receive comprehensive market-agnostic connectivity, transaction and data management solutions.”

Additionally, “expert consulting services are offered for customization or installation of the software and for general advisory services,” NYSE Euronext said.

Buy Beats Build

Exchanges moving into the technology business are benefiting from the wave of cost cutting that has swept through the financial services sector in recent years, which has forced many market participants to retreat to their core competency and tipped the balance of buy-versus-build decidedly to buy.

“As firms are stepping back and reviewing their infrastructures looking for ways to manage costs more effectively, many of them began to realize that there are some technology items that were once viewed as proprietary that are no longer a competitive advantage or a performance differentiator for them,” said Joe Mecane, executive vice president and co-head of U.S. listings and cash execution at NYSE Euronext. “For us, part of that was the realization that many of the things we already develop and maintain, whether it’s matching engines or global networks or market-data infrastructure, are things that we can supply to our customers on a lower-cost basis with less total cost of ownership.”

In a Nov. 30 interview with Markets Media, Mecane said meaningful expansion into the third-party technology business was a “huge accomplishment” for NYSE Euronext, as was the launch of the Capital Markets Community Platform, the exchange company’s cloud-computing service.

NYSE Euronext may be the most aggressive global exchange moving into other businesses, but it is hardly singular in its pursuit of diversification.

Nasdaq OMX offers services spanning advisory, trading, clearing and settlement, surveillance, and market data. On November 29, Toronto-based TMX Group said it would buy Razor Risk Technologies, an Australian provider of risk-management services. The razor purchase came three months after TMX agreed to buy Atrium Network, a European company that connects trading platforms to institutions.

Diversification of exchanges’ business models has yet to catch on globally the way it has in North America. Observers said Asian exchanges in particular have been slow in this area, which may be due to their ongoing focus to expand their trade-matching business globally, rather than expand their business beyond trade matching. Still, there are signs of movement in that direction: member services and connectivity comprised 6% of the Singapore Exchange’s overall revenue in the year ended June 30, 2011, up from 5% in the year-earlier period.

Exchanges are selling technology and trading services for the incremental revenue, but perhaps more importantly, for the customer stickiness that such offerings can provide. The rationale is that if a market participant finds one-stop shopping at a particular trading venue, there will be no compelling reason to buy and sell anywhere else.

“Services and solutions are being provided to capture more order flow,” said Richard Chmiel, vice president of sales and marketing at OneMarketData, which sells tick-data management, analytics and complex-event-processing services. “Exchanges are not just doing it as a way to branch out. In the end you still want to bring more order flow into your own matching engine.”

While exchanges are very formidable competitors in the business of providing technology, Chmiel said he views the encroachment more as an opportunity than a threat. “Exchanges are customers of ours,” Chmiel said, citing OneMarketData’s OneTick data management and analytics product as especially popular. “The market-data feed has real-time and historical value, and many exchanges want to store their own data. For example, the Miami Exchange is using OneTick to store market data.”

Another example of an exchange as a tech-vendor customer is Chicago-based giant CME Group, which has used StreamBase to analyze real-time streaming data since 2009.

Data Providers

The lines between exchanges and providers of technology and market data have blurred, as today’s competitor can be tomorrow’s customer or partner, or vice versa. To illustrate this, Bloomberg LP’s Bloomberg Tradebook bills itself as an agency broker partnering with buy-side and sell-side market participants to provide liquidity. On the other side, exchanges are offering more and more market data to their customers, acting in a capacity that competes directly with companies whose business is provide information to market professionals.

Exchanges increasingly consider themselves as technology companies and “are heading toward a business model like Thomson Reuters and Bloomberg,” said Scott Hall, managing director, North America at low-latency technology provider Activ Financial. “They are definitely seeking other revenue streams as trading revenue goes down. NYSE has been doing this for years.”

Hall noted that exchange’s technology and market-data offerings tend to be more expensive and all-inclusive compared with stand-alone technology providers. “Exchanges tend to offer more robust , or expensive, solutions,” Hall told Markets Media. “They tend to stack costs on without really any bundling of packaging — part of that is because some of fees are regulated. Exchange technology is usually purchased by the higher end, say mid-sized to the largest firms.”

Users of exchange technology and services also tend to be those market participants who do a substantial majority of their trading on one exchange. “You generally use firm like Activ when you trade multiple venues and globally, i.e. have a need for hubs around the world,” Hall said. “It’s a little different client type at the moment, which is probably why we don’t bump into each other much…That could change if exchanges start offering better packaged global solutions.”

“Exchanges are not really looking at mid- and back-office functionality, but they all have clearing and if they don’t, they’re looking to buy,” Hall continued. “They are looking at the full (trade) lifecycle. I wouldn’t be surprised if in five years some of the exchanges look quite a bit like a Thomson Reuters.”

Post-trade clearing is one of an exchange’s highest-margin businesses, and with developing global regulation poised to bring over-the-counter derivative transactions onto exchanges and clearable, it stands to get even more attractive. In November, London Stock Exchange Group said first-half profit increased more than analysts’ expectations, driven by strong results at its Italian clearing business.

Exchanges around the world are seeing similarly strong performances by ancillary businesses.

“If you look in Asia, the only financial entities really doing well are the exchanges – Singapore, Hong Kong, and Shenzhen for example,” said Chmiel of OneMarketData. “Banks are struggling, and the buy side is doing just okay. The entities that are thriving are exchanges, especially those with clearing.”

“Clearing, market-data fees and listings are where exchanges make money, not trade matching,” Chmiel continued. “All of those beget one another — if you are the primary marketplace that will get you more listings — liquidity begets liquidity, and everything follows from that.”

A robust co-location offering is ultra-critical for an exchange to successfully diversify its business, according to Chmiel. “I don’t know of a meaningful exchange that doesn’t have co-location capability,” he said. “I don’t know if the fees are all that interesting, but they want to bring in liquidity by making it fast and easy to get to the matching engine.

“CME, Nasdaq, and other major liquidity venues are placing a high emphasis on co-location,” Chmiel added. “Getting your customers to put boxes in your cabinets and giving them the ability to access the matching engine is a very smart strategy.”

Schwartz of Baruch College, who has consulted for the New York Stock Exchange, London Stock Exchange, and Nasdaq, indicated that the trend of exchanges branching out into additional businesses has more room to run. “You can always push the envelope further,” Schwartz said. “Technology is very dependent on the vision and the imagination of the people developing stuff.”

A primary motivator for developing an expanded technology portfolio is trade-matching margins, which have been squeezed by regulatory and technological forces over the past decade. “The trading business has become more generic,” Schwartz said. You don’t really get the profits there.”

Schwartz said one logical offshoot of the exchange business model is education, which could include programs for internal and external education covering trading and market-structure issues. An educational-services business could bring in revenue for an exchange and also increase the use of other exchange products, Schwartz suggested.

“For investors it is well-known that portfolio diversification is a good way of controlling risk,” Schwartz said. “Exchanges can help manage their own risk by diversifying.”

Ultimately, exchanges’ core business of matching trades is not going away, but it has been commoditized to the extent that those who rely on it exclusively are destined to shrink.

“There is still a strong business around trade matching, but I don’t think it’s enough on its own, particularly on just a domestic basis,” said Mecane of NYSE Euronext. “We will continue to see trends towards product diversification in the trade-matching space as well as continued expansion into other geographies and further diversification into related, non-matching services like the technology business.”

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