Brookings-Wharton Papers on Financial Services 2002 (2002) 1-33
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The Future of Securities Exchanges
THE FUTURE IS not only out there, it is also what we make of it. This paper examines the future of securities exchanges. It seeks both to extrapolate logical conclusions from current trends and to provide a virtual bully pulpit to ensure that all is for the best in the best of all possible futures. Four broad themes relating to securities exchanges are discussed: information, industry structure, governance, and politics. In each area, some predictions are made, and then comments are provided on why the predictions will come to pass and on some of their commercial and regulatory implications.
Securities Exchanges Will Become Media Companies
Advances in computer and communications technology have already changed the way securities exchanges operate in many ways. The implications of recent technological progress have not, however, yet been fully appreciated. 1 It is now the case both that the marginal cost of executing an extra trade on an electronic trading system is close to zero, and that the [End Page 1] marginal cost of delivering quote and trade data to further customers is also close to zero, once the data have been captured electronically. Together these advances will revolutionize the business models that some securities exchanges follow by radically increasing the importance of revenues from the sale of the quote and trade data emanating from such exchanges. 2
Historically, exchanges have had seven main types of revenues: membership subscriptions, fees for listing, trading, clearing, and settlement, and charges for the provision of company news and for quote and trade data. 3 For many exchanges, however, all but the last of these sources is gradually disappearing.
Membership fees will continue to be paid as long as an exchange has members, but demutualization is bringing this to an end. Exchanges now have customers, not members. In many contexts, listing is subject to intense competition between exchanges, and thus the ability to extract high revenues from the provision of this service is limited. Furthermore, there is debate about whether exchanges should, in fact, still undertake this function, when they can use it as a competitive advantage against trading systems that do not provide it. In the United Kingdom, for example, it has been decided that the London Stock Exchange (LSE) should lose its official designation as the Competent Authority for listing, which was handed over to the Financial Services Authority (FSA). The merits of this move are being debated in other jurisdictions. Most securities exchanges do not provide clearing and settlement services, and even for those that do, there is pressure on them to reduce their costs and charges. Only a few exchanges provide company information, and in most environments this service is subject to intense competition from the data vendors.
Transaction fees are the largest source of revenues for most exchanges today. However, this may not continue. As the cost of processing an extra marginal trade on most automated trading systems has now become essentially zero, competition between trading systems is pushing transaction fees to this level. And even this may be too good to last. Payment for order flow already exists in the brokerage market, and it will not be long before this takes root in the exchange market. Exchanges will be paying for the [End Page 2] privilege of executing orders on their trading systems. And indeed, in some contexts, they are already doing this via subsidies provided to market makers and incentives for investors to use their trading systems.
So exchanges' key source of income will have to come from the sale of their quote and trade data. 4 Even when a dominant exchange has faced competition from new trading systems, and even if such trading systems have succeeded in capturing some order flow, very rarely has a dominant exchange ever lost its position as the main source of price discovery for the securities it trades. 5 Revenues from the sale of quote and trade data will therefore be more resilient than those...