Securities Exchanges, Part I: Global Proliferation

The securities exchange industry has grown prolifically behind globalization for nearly four decades, but industry-specific challenges are now clouding its future.  

Each link in the globalization chain tells of a need for risk and capital intermediation, and loosely illustrates why securities exchanges have boomed.  With trade liberalization, trade agreements are inked or restrictions are lifted, and trade routes open up; meaning more exchange of commodities like raw and primary materials, finished goods, currencies, and cross-border payments.  

With financial liberalization, corporations that grow into MNCs with greater global profiles can attempt to access and raise money from new, foreign equity or bond markets; and investors can simultaneously better channel their savings towards those very cross-border investments.  As a result, both corporations and investors also become exposed to more global risk, and need to offset those risks with hedges (see Chart 1 for an example of derivatives exchange growth).  

Chart 1

Notes: The chart starts in 1970 because globalization accelerated in the following decades.  The net number of operational exchanges is shown, with growth indicating more being established than defunct or merged. 

Sources: WFE, FIA, Numa, AFM, IOS, CFTC.

It’s easy to forget that exchanges are living, breathing firms like any other.  After all, the Intercontinental Exchange (parent of NYSE Euronext) and the NASDAQ OMX Group are publicly traded alongside the very thousands of companies that are listed on their own exchanges.  They deal in products and services, and are constantly trying to grow.

The most important business activity of an exchange is providing a place for investors to trade (derivatives, equities, fixed income, commodities), and a place for corporations to list and raise money (cash equities).  Ancillary services often include the provision of market data and analytics to corporations, or of technology to exchanges or clearinghouses in other parts of the world.

For exchanges, organic growth might come in the form of expanding their product lines (e.g., developing faster trading platforms, and innovating new trading products), or expanding whole business segments (e.g., an equities exchange developing its derivatives business).  On the other hand, inorganic growth involving M&A is also a popular route.

The securities exchange industry is always a flurry of activity: international exchanges seeking to expand aggressively by acquiring or merging with smaller, regional operations; smaller exchanges going defunct due to lack of liquidity (i.e., a lack of buyers and sellers or trading activity); and new alternative exchanges being launched all the time to provide liquidity and offer new trading products.  The industry is also intensely competitive.  Not only must exchanges out-price and out-innovate one another, but also they have to fend off other competitors, such as OTC markets run by broker-dealers, and ATNs (which include ECNs, MTFs, dark pools, and matching networks).

Presently, a number of headwinds are engulfing the industry, but there are tailwinds waiting in the wings as well.  In the past few years, low growth, customers deleveraging, and extraordinarily low interest rates all contributed to poor business and low trading volumes.  But developed economies are beginning to reverse zero-interest rate monetary policies, which is a boon for exchanges, as rising rates should bring back fundamentals and trading volume.  The global regulatory overhaul of derivatives (i.e., Basel III worldwide, Dodd Frank in the U.S., MIFID II in Europe, etc.), also, is shifting the market in favor of clearinghouses and exchanges.