Another quarter, another set of record results for exchanges. Quite frankly it’s no wonder brokers are keen to see competition.
The correlation between trading volumes and exchanges’ earnings is clear. Average daily volume at the London Stock Exchange rises by 58% and its profit before exceptionals rises by 55%; the number of transactions on Deutsche Börse’s Xetra platform rises by 49% and its ebitda rises by 47%. For exchanges, more trading means more money.
Yet the same is pretty much true for investment banks’ execution businesses. Unbundling has turned execution into a purely volume-driven business, where profitability comes from economies of scale, so more trading also means more money to investment banks, too, particularly as they use technology to turn themselves into what looks more and more like an exchange or alternative trading system.
Luckily for investment banks and exchanges alike, the imminent competition between execution venues is likely to mean more trading and therefore more money for everyone. New venues with faster, better technology and lower operating costs and fees should help to make the market more attractive to statistical arbitrage funds that trade high volumes, which depend on high speeds and low costs to be economical. Such funds, which now account for more than half the volume of trading in the US, have not found Europe so attractive, but new entrants such as Chi-X, which targets such players and exchange competition generally, could change that.
Fragmentation of liquidity will also make algorithmic trading strategies, which slice large orders into many smaller ones, ever more necessary.
Competition will lead to lower fees but margins at exchanges are so obese that they can easily afford to shed some fat. It might not even hurt that much as lower fees could substantially increase volumes. Goldman Sachs estimates that lowering fees by 30% could increase volumes by as much as 50%.
ATS operators grumble that although they are the ones that spur innovation in the marketplace, ultimately it is the incumbent exchanges that benefit. After years of super-normal profits, smart exchanges should be well placed to put up a good fight and if necessary buy up any upstart that becomes too much of a nuisance.
