Is the ground starting to shift?
In May, Nasdaq OMX Group announced a plan to offer trading algorithms to the members of its exchanges. While the tools would be low-end benchmark tactics and Nasdaq said it would not market them to the buyside, the move encroached on a business traditionally dominated by brokers.
The plan didn’t sit well with the Securities Industry and Financial Markets Association, a trade organization that represents brokers. It filed a letter with the Securities and Exchange Commission, arguing that Nasdaq, due to its regulatory status, would have an unfair advantage over brokers in offering the algorithms.
Then, in July, NYSE Euronext won approval from the SEC to offer a “retail liquidity program” that will attempt to wrest retail order flow away from broker-dealers. Both Nasdaq and BATS Global Markets have announced similar plans.
The brokerage community wasn’t crazy about this idea either. SIFMA and others protested, but the SEC approved the NYSE plan anyway. Recently, SIFMA filed another letter with the SEC, complaining about the BATS proposal.
In August, Duncan Niederauer, chief executive of NYSE Euronext, testified at a hearing of the House Committee on Financial Services that exchanges were operating at a disadvantage to brokerages’ alternative trading systems, with which they compete. He asked Congress to “level the playing field” between the two by reducing the restrictions on exchanges or increasing them on ATSs or both.
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.
