4.5       Dollars & Data Sources (Exchanges): Balance & Profitability

Exchanges do need to find balance in the fiduciary duty to be profitable (for those which are listed) and providing a fee based service which provides the data to promote trading.

If exchanges price the market too high it reduces the overall pool of willing investors. This reduces the number of trades, which reduces the market data output, and the attractiveness of the exchange in the market place.

  • As at 7 April 2017 the Market Capitalisation of the 9 exchanges covered in this section, plus ICE totals US$166,974 Million.
  • CME with a market capitalisation of US$40,110 Million is the largest, followed by ICE at US$36,090 Million and HKEx at US$30,772 Million.
  • CME, ICE, and HKEx combined account for 64% of the total market capitalisation of these 10 exchanges.

Source Bloomberg

Exchanges have not yet maximised their revenue potential for market data. There are new opportunities arising especially via ‘The Cloud’ which offers the opportunity to reach new markets via alternative distribution channels. There is also the development of new market data opportunities in terms of usage, especially in terms of leveraging the trading data they are sitting on.

On the negative side of the ledger like the vendors, income from terminal fees are coming under pressure, however, unlike the vendors the exchanges are in a better place to take advantage of replacement income flows as we discussed in Section 4.3 Business Strategies for Data Sources (Exchanges).

While larger exchanges have moved on to the second generation business (enterprise wide usage), and even third generation business (new technologies and regtech), many exchanges remained fixated upon their terminal revenue flows. These are the exchanges not as exposed to global investment flows that drive the markets in the US, UK, Europe, Japan, Hong Kong, and Australia.

The reasons are not hard to find, global investment flows bring sophistication, greater levels of market oversight, more demanding investors who require a wider range of market data used in more ways across their business than the domestic financial institutions in the rest of the world.

For the larger exchanges any decline in terminal fees, while never welcome, are more than offset by the expansion in enterprise wide usage where data is flowing into trading applications, risk management systems, reporting services, and the plethora of other electronic applications.

Inevitably, there is a correlation between the size of the exchange, the size of the market it services, the openness of that market to global financial institutions in both investment access, and technology access (think DMA), and the growth levels in market data usage.

Market data flows drive business to the centre, i.e. the exchange, which then creates a virtuous circle of usage, because the greater the number of trades occurring on an exchange, the greater the amount of data created, which then is needed by the financial institutions to create the next trade, measure exposure, value a position and be reported.

Financial institutions in markets such as New York, London, Frankfurt, Hong Kong are high volume, high value, with multiple ways of accessing, ingesting, and re-distributing market data. All this information then becomes chargeable services defined by how it is used.

The result is that as in classic economics demand drives the ability to command fees. For exchanges, the greater the level of institutional market share compared to retail, means the greater the ability for that exchange to charge fees as the institutions are forced to subscribe to the data in order to participate in the market and cater for a multiplicity of clients. They need Level 2 or Full Order Book data, and their systems hunger for market data feed.

In comparison, most retail investors at most want or need Level 1 data, and even then, on a delayed basis. Even though these are very price sensitive clients that does not negate their value or impact. Locking out retail clients through charging too high fees is not only a cost deterrent to participation, it can be politically sensitive as well.

The institutional/retail market balance is one exchanges are actually quite sensitive to, especially in markets such as Hong Kong, Malaysia, Romania, and Africa.

Crystal Ball

  • Leading exchanges are more than just venues for transactions, they are becoming more involved in the decision making process through offering value added information services, as well as technology solutions.
  • This is moving them in the direction of becoming venue/vendor hybrids, which is not new, in OTC markets Bloomberg and Thomson Reuters have been these for many years. What is different is that many exchanges are the sole source of information, and while Bloomberg and Thomson Reuters compete to trade GB£, access to the source of say the Microsoft share price is far more limited.
  • Exchanges and data sources will seek more direct routes to clients, bypassing traditional market data vendors. This will be aimed at growing the market and margins but does introduce an element of competition that is more overt than before.
  • However, the symbiotic relationship between vendors and exchanges while coming under strain will not be broken because they both need each other, the exchanges for reach, the vendors for content.
  • Market data vendors will continue to have one advantage, that their aggregation of data means for many institutions access to exchange data is usually cheaper delivered by a vendor than going to the expense of buying direct and then having the necessary infrastructure in place.
  • For exchanges whose fees and policies are regulated, changing their business models in the age of the Cloud (and Uber) will prove a challenge. The process of change will raise issues of vested interest.
  • This could hold the development of some exchanges back, but paradoxically offer different set of opportunities by looking at the retail market in different ways.