Commentary

Richard Repetto
Traders Magazine Online News

Why Do Exchanges Own Multiple Licenses? It's Not Hard To See, Look at the SEC

In this recent research note, Sandler O'Neill + Partners, L.P. Principal Richard Repetto examines why the public exchange operators hold multiple licenses and that rationale behind this phenomenon.

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December 1, 2012

Rebound Disrupted

By Editorial Staff

At that same hearing, Dan Mathisson, head of U.S. equity trading at Credit Suisse, operator of the industry's largest dark pool, also told Congress the playing field was not level. Mathisson, however, argued the advantage was with the exchanges, not the brokers. He asked Congress to eliminate the restriction that limits broker-dealer ownership in an exchange to no more than 20 percent. Then ATSs would become exchanges and the field would be level, he explained.

In November, at an industry conference, SEC commissioner Dan Gallagher suggested the time might be right to strip exchanges of their self-regulatory status. Times had changed, Gallagher said. Exchanges were no longer quasi-governmental mutual associations. They had become profit-driven, shareholder-owned companies. Relieving them of their regulatory obligations would benefit them, he said. Relieving them of their regulatory advantages would benefit the brokerages that compete with them.

So what is going on? Are exchanges becoming broker-dealers? Are broker-dealers becoming exchanges? Are the two business models converging? Brokers like to match trades because they earn two commissions and save on exchange fees. They now execute one-third of all their volume away from the exchanges.

The relationship between brokers and exchanges has always been an uneasy one of cooperation and competition. But this year, as volume continues to slump, the gloves are coming off. Exchanges are trying to grab flow from brokers. Brokers are trying to grab market data revenue from exchanges. (If Credit Suisse were to win exchange status for one or both of its alternative trading systems, it would be allowed to share in an annual $400 million market data revenue bounty.)

Both sides need the help of the SEC to get what they want. NYSE Euronext got a big boost from the Commission when it approved the exchange operator's controversial retail program. Credit Suisse may have at least one SEC commissioner on its side.

What's next? Will exchanges try to move closer to the ultimate prize: the buyside?

They certainly have an opening. Given mounting concerns over information leakage in broker dark pools, the exchanges aren't shy about highlighting the dark side of dark pools. "The buyside has to accept that dark pools are much less regulated than exchanges," Bill O'Brien, chief executive at Direct Edge, said at a recent Investment Company Institute conference.

-Peter Chapman

 

>>Small Caps Trading Increment Poised to Move Higher

Is decimalization to blame for the sharp decline in initial public offerings during the past decade? Are small-capitalization stocks suffering from investor neglect because brokerage houses can't make money trading them? Would rescinding the rule changes to the minimum trading increment spark some life into these "zombie" stocks?

Congress is wondering if a rescission of these rules passed by exchanges in 2000 and 2001, which slashed the minimum trading increment to a penny, would goose trading in smaller stocks. That's why, as part of the Jumpstart Our Business Startups Act, passed in April, Congress ordered the Securities and Exchange Commission to study the issue and consider increasing the minimum tick to some amount between 2 and 9 cents.