The flurry of M&A activity among the world’s largest exchanges might well offer some revenue benefits but it will do little to help the plight of institutional or retail investors. Agreed tie-ups from the London Stock Exchange and TMX, and Deutsche Börse and NYSE Euronext, among many, are responses to a decrease in revenues from cash equity trading as margins have come under pressure from competition.
But to an extent the exchanges have only themselves to blame. Revenues at cash equities exchanges are something of a transaction volumes game. So high-frequency traders have been the customer segment of choice for the past few years. That has been to the detriment of institutional investors, which have had to look elsewhere to transact lest they be subject to the market moving against them.
High-frequency traders have much smaller orders, making it easier to detect large block trades coming into the market. Many will have algorithms in place that react to large sales, potentially instigating a panic sell-off and hindering an asset manager from selling further large blocks of stock.
That has been good news for firms such as Liquidnet that cater entirely to an institutional market. It is the world’s largest independent operator of dark pools and was established in 2000 in the US to focus entirely on the institutional market. Its success points to where exchanges could have been making money had they not turned their backs on institutional investors. Its members hold almost $13 trillion in assets, and it has been able to spread its reach to 39 markets via partnerships rather than time-consuming acquisitions.
The current M&A plans seem to be pushing exchanges further away from addressing cash equities and some of the inherent issues with high-frequency trading such as last May’s flash crash. Instead, the mergers are aimed at reducing a focus on cash equities and turning instead to the more lucrative market of derivatives as well as diversifying across borders (see CME’s Donohue unmoved by exchange consolidation, Euromoney, April 2011).
If exchanges continue to turn their backs on institutional investors, there will be a bifurcation of marketplaces – one for institutional investors served by dark pools and firms such as Liquidnet, and one for high-frequency traders. That raises the question, where will the retail investor go?
