A check on stock exchanges before Halloween makes sense. We covered stock exchanges in a two part series in May, with a focus more on Fintech innovation and naturally, we found Blockchain parties and concerts all over the planet. These activities continue to spread but today I want to highlight the major source of the extended revenue growth over the past 5yrs of Stock exchanges. Lets not fool ourselves by believing that the revenue growth is due to some innovation. It is heavily due to a government created oligopoly that exploits customer transactions data!
When and why did exchanges transform into profit centers?
Exchanges before the turn of the century were serving a global service and were operating very much like utility companies or social servicers. They were scaled versions of Jonathan’s Coffee house in London (original site of LSE) and the Button wood tree in New York (agreement that started the NYSE).
It all changed in the very first few years of the 21st century, not because they were waiting to make sure that computers could overcome the Y2K problem. It was mainly due to the wide adaptation of electronic trading for stocks at least, which led to setting up clearing and settlement businesses like DTCC. These for profit businesses post trade companies led the way to raising capital by accessing the public markets. In the US, it was NYSE In 2005; and in Europe, Deutsche Börse and LSE, in 2001.
The next pivot in their business model of these publicly traded ex-social servicers happened 100% because of regulation. SIP (Securities Information Processor) resulted in an unintended consequence that many believe as a government-led oligopoly of stock exchanges. SIP was conceived to protect end-investors from being taken advantage from those operating the electronic trading circuits. It created a filter, operated by the exchanges, in order to ensure that the best quotes get fed to the broker dealers. Simply said, exchanges which act as aggregators were also crowned with another role, the filtering SIP role.
In addition, the subprime crisis resulted in reduced trading activity and shrunk the market-maker activities. The revenues from trading volume shrank and the business shifted its focus to increasing charges on Market Data feeds. This was and is a captive market – Real-time access to Market Data feeds – is absolutely necessary for brokers, and market makers etc.
Stock exchanges are the aggregators and are continuing to charge an arm and a leg for real-time access to these feeds. In fact, they are the only aggregators that have increasing these charges.
Tabb group reports that the revenues from US stock exchanges have climbed 16% over the past 5yrs, largely due to data revenue. Of course, the acquisition spree that has been happening is very much contributing to these figures too.
Lawsuits on Market data feeds are dragging
There have been multiple lawsuits around this issue. However, the rulings take very long and in the meantime, the exchange sector continues to consolidate, leading to further strengthen of the oligopoly and resulting in fewer and fewer players. The most recent announcement of the BATS exchange acquisition from CBOE takes an innovator out of independent action. ICE is a huge conglomerate with a global web that makes the space very tough to disrupt.
The most significant lawsuit saga continues for more than 10yrs. SIFMA (Securities Industry and Financial Markets Association) and a coalition of Internet companies filed a lawsuit against the exchanges in 2006. In 2013, the U.S. Court of Appeals for the District of Columbia instructed the SEC to reexamine its approval of data fee increases and require the exchanges to justify the price hikes. Since then, the case was awaiting review by the SEC’s own administrative court. This summer, the SEC judge threw out the case and SIFMA has stated that they will appeal the ruling.
The double disruption from IEX: speed bumps and free real-time data
IEX, the sole disruptive force left in the stock exchange space, got approval to operate just 3months ago.
Remember this is the only such business that isn’t heavily influenced and tied to the Sell-side; contrary to all others who came out of a Sell-side membership type of organization before becoming public. IEX is a membership held organization but from the Buy-side! It’s first positioning was-is to use a speed-bump in the way it operates the electronic circuits of the IEX exchange. The purpose is to protect the market from HFT rigging and serve the interests of the Buy side.
The second move, which is upcoming will be-is to offer free access to real-time data to its customers (Kurt Dew, an industry veteran has been covering these issues in Seeking Alpha as they unfold). This is a direct and major disruption to the other players that count on such data feeds constituting a major source of their revenues.
How soon will the data source of revenue disappear for exchanges? Will technology solutions and private markets become the areas of revenues for the exchanges?
Daily Fintech Advisers provides strategic consulting to organizations with business and investment interests in Fintech & operates the Fintech Genome P2P Knowledge Network. Efi Pylarinou is a Digital Wealth Management thought leader.