While exchange operations are scale businesses,greater operational efficiency can only be pushed so far. Exchanges will have to embrace a higher level of innovation to maintain growth rates in coming years. Opimas believesthat innovation for exchanges will occur in areas such as alternative data, trading of digital assets, and capital formation.
A newOpimasreport,Exchanges: Innovation and New Business Models to Drive Growth, authored by founder and CEO Octavio Marenzi, looks at how innovation will play a key role in the future of exchanges and what pockets of opportunity are most likely to drive revenues(I haveattached the full reportfor your perusal).
Key findings of the report include:
- Exchanges have been able toincrease their revenues at double-digit rates annually, reaching close to US$30 billion in revenues in 2018, having grown at an annual rate of 11% since 2012. Most exchanges are highly profitable, with average margins about 60% and with a number of players enjoying profit margins that exceed an astounding 70%.
- The exchange business is one dependent on scale, as reflected by the many mergers over the past 20 years. The larger an exchange becomes, the lower its operating cost per trade falls. Indeed, trading volumes explain most of the variation in cost per trade.And yet Australian Securities Exchange is about 10 times more efficient than would be expected for an exchange with its trading volumes. The two large Chinese stock exchanges, Shenzhen and Shanghai, also are very efficient, with the lowest cost per trade globally.These exchanges achieve such efficiency levels by operating with very limited staff compared to exchanges in the rest of the world.
- In 2018, proceeds from IPOs were slightly above US$200 billion, essentially flat compared to 2017. However,the first quarter of 2019 has seen IPO volumes come to a screeching halt, with a decline of about 70% compared to the first quarter of 2018.European IPOs have been particularly hard hit, with a decline of over 95%. In Asia-Pacific, the declines were less pronounced, but nevertheless saw a fall of about 30%.The direct impact of such a decline in IPOs on exchange revenues will be fairly muted and will be most keenly felt by the investment banks that facilitate these deals.
- In equities trading in 2018,volumes in the US were up sharply, while in China, a multi-year decline in trading volumes continued, after spiking in 2015. This allowed Europe to overtake China in 2018. Roughly two-thirds of US equities are traded on exchanges, with alternative trading systems accounting for only 12% of volumes.
- Exchange revenues from derivatives trading have continued to rise. Chicago Mercantile Exchange stands out as the most diversified derivatives exchange, and volumes at ICE and CME have risen substantially over the past five years. At Eurex Exchange, on the other hand, volumes have remained largely flat, despite the exchanges attempts to introduce contracts on asset classes outside of its core business of equity and interest rate derivatives.
- Volumes at the central clearing houses operated by exchanges have benefitted enormously from clearing and margining requirements introduced in the wake of the financial crisis. The boost that clearing volumes received from regulatory changes look very much like a one-time phenomenon.
- At some of the largest exchanges, including CME, Deutsche Brse, and LSE, revenues for their traditional market data offerings have actually been declining. For those exchanges where we have seen strong growth, this has typically come from areas such as indices or analytics and has been fuelled by a large number of acquisitions in the area, including in alternative data.Nasdaq has been pursuing the alt data area most aggressively, creating the Nasdaq Analytics Hub in 2017, and acquiring Quandl, one of the leading providers of alternative data, in late 2018.
- A number of exchanges now generate far more from data than they do from trading and clearing. However, data still account for a minority of revenues for most exchanges. Over the coming year, we expect to see a number of these exchanges make acquisitions to bolster their data businesses, as they continue to seek additional revenue streams.
- The considerable profits being generated by crypto exchanges will lead more traditional exchanges to carefully consider this market. Security token offerings represent another area in the digital asset space attracting the attention of exchanges (see Opimas report Security Token Offerings Take on Incumbents and Big-Money IPOs).Rather than offer an alternative to existing equities and bonds, we believe that tokens’ range of application is more likely to be limited to pre-IPO companies, typically backed by venture capital, and less liquid assets.
- Exchanges could play a far more active role in the area of capital formation, particularly given the dissatisfaction with the traditional IPO process and the large fees commanded by the underwriting investment banks. In this area, exchanges could provide greater support in terms of advice, as well as systems to facilitate the process.
- The SEC has been making noise about the regulation of US stock exchanges. Undeterred by a pilot looking at tick sizes for small-cap stocks that appeared to not yield any useful results, the SEC has announced that it intends to embark on a far more ambitious pilot examining exchange transaction fees. Already, the three major US equities exchanges have filed lawsuits against the SEC on this front. While results from this pilot are more than two years away, the potential damage to US exchanges-if they were to implement even part of the restrictions on fees and rebates-would be considerable.
