The market is rife with speculation that Merrill Lynch and Citadel, a large US hedge fund, each plan to buy a 10% stake in the Philadelphia Stock Exchange.
The move is the second recent significant development in the US equity market since the New York Stock Exchange announced its merger with electronic rival Archipelago and Nasdaq its merger with I-Net, a leading ECN.
Shortly after those announcements, Knight Trading Group bought Attain, a small ECN, in a strategic move that competitors and industry analysts believe could help the broker exploit new market data revenue opportunities that arise out of the recently approved Reg NMS and give it a pivotal role in any backlash from the reduced competition among US exchanges.
Merrill's move could be aimed at something similar.
"As exchanges move toward new governance structures, there is the potential for bifurcation of interests between users and shareholders," says Samir Misra, a director at Mercer Oliver Wyman. "Users may fear a reduction in competition as a result of the recent consolidation. By buying a stake in an exchange, brokers get the chance to influence the future direction of exchange innovation and competition, while also positioning themselves to capture some upside from subsequent appreciation in value of the exchange."
Hedging move
Other analysts agree. "It seems like a hedging move by a large broker to make sure there is a viable alternative to the NYSE-Archipelago, Nasdaq-I-Net duopoly," says Sang Lee, managing partner of Aite, a financial services technology consultancy. "We've seen similar activity before, in fixed income, where brokers took stakes in a number of competing platforms."
For the Philadelphia Stock Exchange, a bigger player in the options market than in cash equities, the move looks like a survival strategy. In options too, the imperial intentions of the NYSE and Archipelago are clear. The extreme concentration of liquidity into just two main market centres threatens their already peripheral status. Liquidity isn't going to flow to them because of competition fears yet, but they need to do something. Extra cash and some savvy investors can only help.
Merrill, Citadel and the Philadelphia Stock Exchange declined to comment.
At least one and now it looks like two brokers have made moves to counterbalance exchange consolidation in the US. Expect more to follow suit.