Evolution of Exchanges

Terry Flanagan

As exchanges have evolved from mutualized, member-owned entities to public corporations, it has also created an inherent conflict of interest.

In the past, stock exchanges were mutualized companies, owned by broker-dealers, the ones that used them. CME Group in 2000 became the first U.S. securities exchange to demutualize, going public through an initial public offering. The transition to a public company is drastic, as a public company’s first obligation is to its shareholders, and to return the most money to the bottom line. This creates a difficult balance for public companies, but especially for exchanges.

“Lived in both worlds, the way an exchange competes today is night and day,” said Gary Katz, president and chief executive officer of the International Securities Exchange. “There is no comparison between an exchange that is focused on making money and one that is a utility. It’s not just capital issues or new technology and products, but also the mindset of the people that work at the company. There are completely different drivers for success.”

That is the inherent conflict of interest that exists for publicly-trade exchange operators, as it becomes difficult to provide a good service, reliably and at an affordable price point, while also trying to appease shareholders by generating revenue and profits while maximizing the company’s value.

“Exchanges were a utility,” said Alfred Berkeley, chairman of Pipeline Financial Group. “By being public you have the money to grow and invest, but the disadvantage is you have to make money. It’s a very tough balance.”

Maximizing shareholder value can take many forms, with consolidation becoming a more common option in recent years. With competition increasing and order flow declining, exchanges are finding that the best option to maximize value is to consolidate with competitors and become larger, more global entities.

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