Max Bowie: Counting the Cost of the Consolidation Craze

Proponents of the current frenzy of exchange mega-mergers—including Deutsche Börse’s bid for NYSE Euronext (and the counter-bid from Nasdaq and the IntercontinentalExchange) and the London Stock Exchange’s bid for TMX Group, as well as the failed merger between the Singapore Exchange and the Australian Securities Exchange—claim they will produce more efficient markets and deeper liquidity with a broader and more valuable pool of market data. But what do these deals really offer their clients among market data consumers?

Certainly an exchange that combines several markets has more data to offer its clients, and the economies of scale that these deals deliver for the exchanges should allow them to pass savings on to customers. Often, however, while these deals do indeed make more data available, clients also find themselves paying more for the privilege.

However, clients should be able to claw some of that back as a result of lower connectivity costs: instead of needing connections to two entities, trading firms now only need to connect to one entity, since a merged exchange typically makes access to all markets available through a single point of access—though there is also a risk that a merged exchange will consolidate its datacenter space, forcing firms to move from one datacenter to another.

But for the most part, these moves are primarily designed to benefit the exchanges themselves, with the synergies achieved contributing to better margins, or being set aside in a “war chest”—for example, when lowering transaction fees to compete with rival markets.

But data consumers complain that all too often, these synergies don’t find their way back to loyal customers in the form of savings, begging the question of who exchanges are trying hardest to please—customers or shareholders?

Subtle But Significant
Over recent years, two trends have subtly but significantly reshaped the exchange landscape: One is the demutualization of exchanges, shifting ownership from exchange members to the open markets, and making exchanges primarily accountable to shareholders. The second is that stock exchanges are increasingly seen more as pools of liquidity for high-frequency traders and speculative hedge funds and prop shops than the capital-raising venues they once were, with these participants creating more data—which in turn increases data costs—but not necessarily valuable data.

Now, I’m not advocating a return to the exchanges of olde, since I believe these changes are just evolution at work in liquidity pools rather than gene pools. But I do wonder whether this narrower focus has left exchanges more vulnerable to challenges from non-listing markets such as MTFs, forcing them to set their sights on scale through globalization and a more diverse product set than low-margin equities.

This strategy makes M&A activity key to acquiring market share and new products, but also leaves them vulnerable to others pursuing the same strategy. For example, if Nasdaq fails in its joint bid for NYSE, how else will it compete against a merged NYSE-Deutsche Börse with more products and resources? And would such a deal force Nasdaq into a deal with another exchange on less than favorable terms, just to ensure it has the clout to compete? And if so, might we see the London Stock Exchange—for which Nasdaq waged a dogged but unsuccessful takeover campaign only a few short years ago—show an interest in Nasdaq, to create (in conjunction with its TMX merger) a triangular collection of three large Western markets that mirrors the trading patterns of cross-border traders?

Speculation aside, each of the deals on the table has the potential to create bigger, broader and deeper markets that could bring true benefits to traders, and could deliver innovative new solutions for data delivery and pricing—the LSE’s new policy on pricing has drawn particular praise from some quarters—as well as placing them in strong positions to compete with other markets. And if they focus on keeping customers happy, the competition issue should take care of itself.