The most interesting tidbit from this year’s IDX was a seemingly offhand comment made by ICE CEO Jeff Sprecher at the exchange leaders panel. Regarding open access and clearing interoperability, which European regulators are pushing to maximize customer choice in execution and post-trade services, Sprecher said exchanges will be further incentivized to list each other’s products, with execution eventually becoming a loss leader for exchanges.

He said “take the economics out of execution, then make it back elsewhere,” which simply means more fees for data, clearing, connectivity and other add-ons. As a sort of unscientific poll among IDX attendees, I asked a number of professionals what they really thought of the idea. Each anonymous quip is followed by my view.

“You can’t give your product away without lowering the value of your enterprise.” (from a career technologist)

I was rather shocked to hear that comment, as you most certainly can. Google has earned itself a market cap of $506 billion, and many of its products are free to the end user. The trick, of course, is to make money off of “free.” Those that figure out a way to make money off of “free” get to survive. The rest will struggle. The key is to somehow differentiate.

“Sprecher is just talking his book.” (from an executive at a competing exchange)

ICE has spent considerable time and even more money scooping up small (and in the case of Interactive Data, not-so-small) data companies. Why? Google gave us the answer sheet. We do not get to use search engines, maps, YouTube, and everything else for free; rather we are paying with data. Data has tremendous value. Data is the currency of the Internet, and could very well become the de facto currency of the trading space.

“Execution fees are only one component of transaction cost. Liquidity and capital efficiency can be much greater costs.” (from a buyside firm)

Great point, and, depending on how one looks at it, could either bolster the race-to-zero view, or run counter to it. CME Group interest rate suite, for example, prides itself in the deep liquidity of its product mix, and the capital savings from cross-margining and now portfolio margining. Does this mean customers will continue to pay for quality execution? Or will an interoperability regime mean that customers will pick and choose from the a la carte menus, driving down fees everywhere?  

I see a tremendous opportunity for the tech firm that can deliver robust, cross-platform transaction cost analysis.

“New technologies such as blockchain will allow exchanges to lower costs without sacrificing the bottom line.” (another exchange leader)

Another good point, and one that bodes well for the exchanges. If fees become commoditized, it will be hard to justify pricing these publicly-held entities as growth stocks. Utilities, as a rule, do not enjoy price/earnings ratios in the 20s and 30s, as exchanges currently do. But squeezing the inefficiencies out via process improvement will at least buy some more time.

Additional thoughts: When CME offered certain buyside customers a break on swap clearing, they jumped on the opportunity. But since most were asset managers hedging out their fixed portfolios, they were all on the same side of the trade. Since the other side of the trade still preferred to clear through LCH, imbalances built up. Interdealer brokers began offering “switch trades,” but at a price. The equilibrium is essentially the  difference in the costs of clearing and the value of capital efficiencies.  

The lesson? Markets seek an equilibrium. Exchanges will compete, and regulators will set the rules, oversee, and in some cases, like it or not, pick the winners and losers. In the case of open access, exchanges will need to stake their respective claims, through service differentiation, cost efficiencies, and/or revenue streams through data.

Let the competition begin.                                                                                             

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