Capital Markets Bright Spot: Exchanges

Shanny Basar

Total exchange revenues are expected to exceed $20bn for the first time this year and there will be more mergers as they seek to diversify their businesses and benefit from economies of scale according to consultancy Opimas.

Octavio Marenzi, founder and chief executive of Opimas, said in a report: “The world’s exchanges are one of the bright spots in capital markets and investment banking, with total revenues growing and expected to exceed $20bn (€17.8bn) in 2016. Profit margins for exchanges remain remarkably high, with an average of about 60% for leading exchanges.”

Marenzi leads the consultancy’s asset management and equities trading practice. His report said the best exchanges are almost 100 times as efficient as the weakest players with only about half of this difference due to scale or transaction volumes. The most effective exchanges were Bats and the Australian Securities Exchange with costs of about $0.03 per equities trade compared to $1 and $2 per transaction for the most inefficient.

He told Markets Media: “Inefficiency can be due to location and labour costs but is mostly due to technology. Bats has done an excellent job and has been able to use the newest technology in a rational way as it did not have any legacy systems.”

The need to become more efficient has driven mergers and Marenzi expects more deals as exchanges look to diversify their revenues both geographically and by products. He said possible deals include Euronext, the pan-European exchange operator adding post-trade and clearing businesses, Nasdaq acquiring Euronext, a merger between the CME and CBOE, two US derivatives markets, or an acquisition in Asia.

Octavio Marenzi, Opimas

Octavio Marenzi, Opimas

The London Stock Exchange Group and Deutsche Börse have announced a merger and said they expect annual cost savings of €450m. Marenzi said: “To achieve €450m a year in cost savings they will have to cut or consolidate a lot of systems.”

The combined group intends to maintain separate headquarters in Frankfurt and London but connect the secondary cash markets of London, Frankfurt and Milan through a liquidity bridge. The new company will keep separate UK and German clearing houses – London Stock Exchange’s LCH and Deutsche Börse’s Eurex – with their separate data centers and management, but offer cross margining benefits to clearing members.

Amir Khwaja, chief executive of analytics and research firm Clarus Financial Technology, said in a blog that the total combined initial margin of Eurex and LCH SwapClear at the end of last year was $119bn, just above the combined initial margin for the three CME Clearing Services of $118bn. However LCH also has margin from other services such as RepoClear taking the combined total to $130bn.

“We can see that the proposed merger of LSE and Deutsche Börse will create a market leader in clearing,” added Khwaja. “We will see how the vertical integration of Deutsche Börse plays out versus the horizontal integration of LSE.”

The proposed merger needs to be approved by both sets of shareholders, regulators and most importantly, the competition authorities.

Marenzi said: “In coming years we anticipate that exchanges will continue to merge, expanding their less cyclical subscription-based services such as market data, and will push into territories currently occupied by sellside firms and inter-dealer brokers.”

Market data has been the strongest growth area for exchanges as the only segment showing double-digit growth. “Outside of the US equities markets, exchanges have what almost appears to be monopoly pricing power over their data – market participants currently seem to have no choice but to buy the dominant exchange’s market data, giving the exchange considerable latitude in price setting,” added the report.

MiFID II, the new regulations covering financial markets in Europe from 2018, say that market data fees must be “reasonable” but do not detail how this will be defined. As a result Marenzi expects market data fees in Europe to increase.

In addition to market data, derivatives trading and clearing continue to show healthy growth, while listings and cash trading are essentially flat.

The consultancy said another potential growth area for exchanges is to offer services that have historically been provided by the sellside. Banks face regulatory constraints and are reducing their balance sheets, particularly in fixed income markets, and more products are moving from over-the-counter markets into central clearing.

“For example, smart order routing, already provided by exchanges for US equities, is likely to become more common for derivatives exchanges,” said the report. “The same is true for European and Asian equities.”

Marenzi said exchanges could also offer more sophisticated order types, including algorithmic trading strategies, and move into multi-asset trading strategies. Exchanges have traditionally not competed with the sellside who are core customers, and in many cases former owners, even though broker-dealers are constantly looking to create alternatives to exchanges.

“With rising numbers of exchange mergers spanning asset classes, we expect more offerings of the different products available within the same exchange,” added the report. “To diversify their product lines, exchanges must increasingly position themselves as alternatives to sellside institutions. That is an uncomfortable activity for them, but considerable revenues are at stake.”

Featured image by DiMmEr/Adobe Stock

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