Mergers are often the top choice for exchanges attempting to continue to reduce their operating costs and diversify their revenues.
However, not all mergers pay off and a recent report from consultancy Opimas says bourses should consider more creative strategies, which involve moving more aggressively into the space occupied by banks and securities firms.
“We expect exchanges will continue to consolidate, with the announced merger between the London Stock Exchange and Deutsche Börse simply being the latest in a long line,” said Octavio Marenzi, founder and chief executive of consultancy Opimas.
“While the logic underpinning these mergers appears to be watertight, migrating to a combined platform can be fraught with difficulties."
A handful of exchange mergers in the past have failed to live up to expectations as they dealt imperfectly with technical and organisational difficulties in integrating the operations.
Going forward, Marenzi reckons exchanges may have to overcome a deference to the sell-side, which formerly owned them.
"In most industries, business strategies aimed at moving up and down the value chain are considered absolutely normal. However, vertical integration of the exchanges has not come naturally," explains Paris-based Marenzi, who previously worked at Celent and Oliver Wyman.
"They have been extremely reluctant to trespass on sell-side firms’ territory and offer products and services that might be competitive."
This, he says, is understandable given that sell-side firms are exchanges’ core customers and there are risks in offending them. However, this deference has deeper roots.
"The current generation of senior exchange managers came of age in a market where banks and securities firms were not only the virtually exclusive users of the trading platforms, but actually owned the exchanges.
"Few member-owned exchanges remain, and those that were once operated on a semi-profitable basis for the benefit of the banks and broker-dealers who owned them are gone."
However, Marenzi says a reluctance to alienate former members persists. Unfortunately for exchanges, this favour is not returned.
"Broker-dealers are constantly creating alternatives to exchanges in an attempt to reduce their dependence on them and shrink the fees that exchanges can charge.
"In the future, we expect the boundaries between sell side and exchange to blur more and more, with exchanges increasingly performing functions that have historically been reserved for broker-dealers."
For example, smart order routing, already provided by exchanges for US equities, is likely to become more common for derivatives exchanges. The same is true for European and Asian equities.
Moving forward, Marenzi expects exchanges generally will continue to flourish and form one of the few bright spots in capital markets.
Opimas stats show profit margins for exchanges remain remarkably high, with an average of about 60% for leading exchanges.
Total revenues for exchanges globally are growing and expected to exceed $20bn in 2016.
However, it won’t be plain sailing for exchanges to hold onto their pricing power.
“The sell-side is experimenting with cheaper alternatives to trading," Marenzi adds.
"Leaner, upstarts could take market share, and European regulators have ruled that fees for the fast-growing business of providing market data must be “reasonable.”
In coming years, he anticipates that exchanges will continue to merge, expanding their less cyclical subscription-based services such as market data, and will push into territories currently occupied by sell side firms and inter-dealer brokers.
Data from Opimas shows BATS and Australian Securities Exchange (ASX) are among the exchanges with the lowests costs, spending only about $0.03 per equities trade.
Meanwhile, the Spanish and Swiss exchanges occupy the unenviable end of the spectrum with a $1 or $2 fees per transaction respectively.
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