Now an Exchange, Direct Edge Looks to Add Revenue and Cut Costs

Now that Direct Edge has officially launched its exchange operations, it can explore a potential revenue stream that other exchanges have tapped.

Direct Edge said it will start selling its proprietary market data. Sometime over the next few months the newly christened Jersey City, N.J.-based exchange operator expects to begin offering new market data products, said Bill O’Brien, its chief executive.

"The [proprietary market data] space is ripe for competition," O’Brien said. "As an exchange, we can look at building out that business now."

At 9:30 a.m. yesterday, O’Brien flipped the switch to launch its EDGA and EDGX exchanges. Direct Edge says that more than one billion shares trade routinely at the two exchanges each day. This has allowed its combined market share to climb beyond 12 percent. Currently, it is hovering just below 10 percent. On a corporate level, Direct Edge ranks fourth among exchanges, following NYSE Euronext, Nasdaq OMX and BATS Exchange.

Direct Edge’s two markets, EDGX and EDGA, have pricing schedules to attract different types of market participants. EDGX offers a high rebate for liquidity providers and has a take fee for those removing liquidity–a model that would appeal to rebate seekers. EDGA charges a small fee to provide and take liquidity. In the past, O’Brien has described it as a model that would draw "cost-sensitive removers of liquidity."

A consortium that includes the International Securities Exchange, Citadel Derivatives Group, Goldman Sachs Group and Knight Capital Group owned more than 91 percent of Direct Edge. JPMorgan and four other broker-dealers owned the remaining portion.

Direct Edge took over operational control of the ISE Stock Exchange in 2008. The ISE Stock Exchange became a wholly owned subsidiary of Direct Edge Holdings. Direct Edge said it would decommission the ISE when EDGA and EDGX exchanges launched.

Exchanges, such as the NYSE and Nasdaq, sell their proprietary market data to traders who want to see their live depth-of-book and historical data.

"There are many users for the data," a Direct Edge spokesman said. "These include firms that develop algorithms to make trading decisions based on the data, vendors that use the data to publish best price and last sale information to the public and academics who study the markets."

Direct Edge said it couldn’t estimate how much in revenue the market data business would generate. As an Electronic Communications Network, Direct Edge gave away its bookfeed–or level two market data–for free. It did not offer a wide range of market data products.

Aside from market data, a real monetary benefit to exchange status comes from the clearing side of the business. The exchange operator no longer pays most clearing charges. With this in mind, Direct Edge expects to save more than $10 million a year on its clearing costs, depending on volumes.

Direct Edge sat between the buyers and sellers it matched back when it was a broker-dealer-operated ECN. It would sell to the buyer and buy from the seller. It would perform the trades on a riskless basis and at exactly the same price, the firm said.

But Direct Edge would have to pay to clear both trades. As an exchange, it no longer does, as it no longer sits between the two parties in the transaction.

"The only clearing fee we have to pay is if orders are routed out," a Direct Edge spokesman said. "That’s a substantial savings."