Three New U.S. Exchanges Launch this Month:  Why Now?

U.S. equity market structure is heating up once again as three brand new US equity exchanges are launching within the span of a month.  LTSE launched on September 9th, MEMX on the 21st, and MIAX PEARL Equities will launch on the 25th.  But why?  What makes U.S. equity markets so hot right now?

It is simple, really.  It is all about economics and influence.

The Economics of U.S. Equity Trading

U.S. equity trading represents a $2.2 billion revenue opportunity for the exchange industry, with revenues from trading, market data and listings all feeding into the businesses. And revenues have been steadily increasing in recent years, rising by 7.2% annually since 2017.  Much of this is driven by this year’s unprecedented Pandemic-driven trading explosion, which is resulting in surging net trading revenues for exchanges.  Net trading revenues (total revenues less liquidity payments) are projected to total more than $906.0 million this year, an annual record and a 33.6% jump from 2019.

There is more than just trading revenues at stake.  The buzz around market data is an important factor driving launches.  Not only because proprietary products and SIP shared tape revenue are expected to represent a $652.6 million business this year but also because the new exchanges will get both a seat at the SIP table and a slice of shared tape revenue which will total over $400 million industry wide in 2020.  But a seat at the table is pivotable and the influence it welds can expected to bolster industry reform efforts around SIP governance.  More about that in a moment.

Lastly are the appeal of listing revenues, which generate $660 million annually for U.S. exchanges.  IPOs and ongoing listing agreements are a cornerstone of long-term relationships between exchanges and listing companies.   The relationships tend to last for decades, with exchanges constantly being measured on the package of services they provide for annual listing fees.  It is a mix of branding, corporate service and ultimately underlying liquidity in a company’s stock that cements these ties.  The chart below illustrates Burton-Taylor’s projections of how much revenue U.S. equity exchanges will generate in 2020 (see Exhibit 1).

Influencing Market Structure and Industry Governance

Although new exchange launches are ostensibly about lowering costs and economic returns, the influence these new exchanges have on equity market structure cannot be ignored, especially as the SEC takes a hard look at Reg NMS.  Running an exchange comes with considerable influence in Washington, on industry committees, at industry events, and of course on the SIP governance committee.  And if you look at who is backing these new exchanges, you would expect that their voices will be heard loud and clear in all of these venues.  Underlying board and management committees at each exchange will certainly play a role, as their memberships are well-staffed with industry experts who will have an opinion on future market structure.

The backers of MEMX and MIAX PEARL Equities reads like a Who’s Who of the U.S. equity industry, with MEMX backed by a broad constituency of market makers, routing firms and both retail and institutional broker dealers.  MIAX is backed by a broad range of market makers and liquidity providers, along with broker dealers, routing firms and of course their existing option market participants.  Interestingly, both exchanges have many of the same backers, illustrating the diversification strategies and need to be everywhere for the largest U.S. equity market participants.

With LTSE, there are different dynamics at play.  Its focus on social and governance issues plays well in today’s shifting political and cultural environment.  It does not hurt that many of its founding investors have deep ties to Silicon Valley.  LTSE’s ESG-like focus will clearly be seen and heard in Washington, especially if the Biden-Harris team gets voted into office.  Ms. Harris’ ties to California and it’s technology industry cannot be ignored.

A presence in Washington has always been part of the equity market mosaic.  But as the SEC revisits Reg NMS, the influence these new exchanges can bring to the table can ultimately be expected to disrupt the status quo.  New alliances will be formed, and incumbents will face a radically different governance process, especially as market share begins to migrate to the new exchanges.

A Short History of U.S. Equity Exchange Mergers, Acquisitions and New Launches

The recent rush to launch an exchange into a market with 13 existing equity exchanges may be unusual but it certainly is not unprecedented.  Blockbuster acquisitions have been the norm over the past 15 years, with Cboe Global Market’s acquisition of BATS and ICE’s acquisition of NYSE perhaps the most prominent developments in the past decade.

We all know that history often repeats itself and given the past we can be certain there will continue to be plenty of consolidation in the years ahead.  Capital events for each new exchange is a given, especially given the magnitude of revenues that are driven by exchanges. A look at capital events over the past 15 years is telling (see Exhibit 2).

Market Complexity May Get Worse but Ultimately the Industry Will Benefit

The importance of U.S. equity markets to global capital markets cannot be overestimated.  As U.S. equity market structure evolves, its impact on investors and broker dealers around the world can be substantial.  And as three new exchanges build out their presence, U.S. equity markets will experience subtle, yet meaningful changes.  Market shares will shift, economics will change, and industry associations and regulators will have to add even more chairs at meetings and in conference rooms as tables get crowded and industry governance becomes even more complex.

One thing is clear, however.  The entrance of three new entrants will disrupt the status quo.  Although market structure will become even more complex in the short term, innovation brought by these new exchanges will ultimately benefit U.S. equity markets over time.  Short-term costs will rise as industry participants build out connectivity and support but over time competition among 16 exchanges will ultimately provide more trading choices and potentially lower costs across the industry.

Our new report, A Review of the U.S. Equity Exchange Landscape provides a comprehensive review of existing U.S. equity exchanges and analyzes the prospects for new equity exchange launches from MEMX, MIAX PEARL Equities, Long Term Stock Exchange, and the Dream Exchange.  The report analyzes U.S. equity revenues by exchange and includes an analysis of transaction-based revenues, market data revenues, and listing revenues.  More information on the can be found here.

Andy Nybo is Managing Director at Burton-Taylor International Consulting, part of TP ICAP group, where he is responsible for managing all operations and business activities of the company. He has more than 30 years of experience in research and technology applications in global securities markets.

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