The recent evolution of the world’s exchanges is a story of dynamic transformation. Until the 1980s, exchanges would, in their essentials, have been recognisable to a merchant who was trading in the 14th century – the time of their inception.

However, the advent of computers made the trading floor redundant, eliminating the need for proximity and removing the constraints on scale and duration of trading that proximity imposed.

At the same time, a fundamental change has been taking place in the legal structure of exchanges. Until recently, almost every exchange was essentially a club, owned by and run for the benefit of its members. But in recent years many exchanges have corporatised, demutualised and sought a public listing. These corporatised exchanges behave like any other public company. They are driven by the need to satisfy the demands, often short-term, of their new owners, the investors.

The other transforming force influencing exchanges has been competition. During most of the 20th century, many stock exchanges had a monopoly of trading in their city and region, if not their entire country. But during the 1990s, especially in the US, significant new players emerged in the form of alternative trading systems or electronic communications networks.

These new players attracted substantial trading volume away from the established exchanges, which responded by developing similar order-driven systems or by taking over some of the most successful of these new entities. The New York Stock Exchange (NYSE) acquired the Archipelago Exchange (ArcaEx), while Nasdaq, which had acquired Brut in 2004, acquired the Instinet ECN in 2005.

We are now seeing new players entering the market in Europe, driven by the EU’s Markets in Financial Instruments Directive (MiFID). The Directive, which became effective in November 2007, harmonises rules across member states and also requires investment firms to seek best execution in most asset classes. These new rules have given rise to new trading venues such as Turquoise, owned by BNP Paribas, Citi, Credit Suisse, Deutsche Bank, Goldman Sachs, Merrill Lynch, Morgan Stanley, Société Générale and UBS. Significantly, these firms represent some of the major customers of the incumbent exchanges, making their potential defection to the new venue even more of a threat.

Widespread change

Nor is change restricted to the cockpits of Europe and North America. In Australia, for example, we find Liquidnet and AXE seeking licences to compete with the Australian Securities Exchange. The established exchanges argue, as one might expect, that a single exchange has benefits in terms of a greater pool of liquidity, and that a fragmented market will hurt small investors. Although ultimately it will be the decisions of the big investors that are crucial, it seems that the competition being engendered can only be in the interest of their small customers.

These new exchanges are not limited to equities trading. In the derivatives space there is a new entrant in Europe – Project Rainbow – whose co-owners include Barclays Capital, Deutsche Bank, Goldman Sachs, JPMorgan Chase & Co, MF Global, NewEdge and UBS. Interestingly, Rainbow is reported to be in discussions with an existing exchange – the London Stock Exchange (LSE) – about using its established but low-volume derivatives platform as a quick route to market. In the US, a group of 12 leading financial institutions, including some of those behind Rainbow, has announced a new futures exchange called the ELX Electronic Liquidity Exchange. Such projects could address fungibility issues in the listed derivatives market and ultimately reduce costs for investors.

Competition has forced exchanges to invest substantial capital in new technologies as they have mostly moved from a floor-based trading environment. Substantial investment in the latest electronic trading systems continues unabated. NYSE Euronext recently acquired Wombat, a deal which is important for next-generation trading systems as the speed of quote and trade traffic is measured in sub-milliseconds.

Exchanges are also embracing off-exchange trading (sometimes known as dark liquidity pools). NYSE Euronext has announced plans to link to two different dark pools: BIDS Trading in the US and SmartPool in Europe. SmartPool is a joint venture between HSBC, BNP Paribas and NYSE Euronext. Elsewhere in Europe, SWX Group, operator of the Swiss Stock Exchange, has announced that its SWX Europe subsidiary has teamed up with Nyfix Millennium, operator of US dark liquidity pools, to run a venture in Europe for Swiss blue-chip stocks.

A further area for growth has been the range of instruments and product types that can be bought and sold. The 1997 Kyoto Protocol led to the emergence of a new breed of exchanges which provide a platform for trading excess emission credits. This market is poised for huge growth once new global benchmarks have been set for transparency and risk assessments. Although still a relatively young area, there are already about 15 markets trading or about to trade in carbon, both at existing exchanges and new entrants.

Products and services

Finally, competition is encouraging exchanges to move out of their traditional areas and to develop or acquire new products and services. NYSE Euronext has launched a new web-based pricing service to help buy-side firms to place market valuations on their complex structured products and illiquid securities. CME Group is one of many exchanges that is interested in the large over-the-counter market and has recently acquired London-based Credit Market Analysis, a provider of credit derivatives market data. Five years ago, these services would never have associated with an exchange.

Another result of the transformation of exchanges from member-owned to investor-owned organisations has been the wave of consolidations and mergers sweeping across the sector. Euronext was one of the first examples, bringing together the Paris, Amsterdam, Brussels and Lisbon bourses, before merging with New York to create NYSE Euronext, the first trans-Atlantic exchange. Recently, we have seen the merger of Nasdaq and Sweden’s OMX to form the Nasdaq OMX group, which will also own one-third of the Dubai International Financial Exchange.

We can expect this year to be as merger and acquisition-hectic as the past five years – with a merger announced in Brazil between the Bolsa de Mercadorias e Futuros and Bovespa; NYSE acquiring the American Stock Exchange; and CME, already merged with the CBOT, now poised to acquire NYMEX. In summary, all significant exchanges are now ‘normal’ companies, and as with any other company, the ones that do the best are those that combine relentless innovation with great marketing and great management.

Progress update

So how are they doing? How have those sleepy, conservative organisations fared when transformed into companies without the safety net of member ownership, and exposed to the fierce winds of the modern economy? One of the best measures of this is provided by the FTSE/ Mondo Visione Exchanges Index.

The Index, a joint venture between FTSE Group and Mondo Visione, established in 2001, was the first in the world to focus on listed exchanges and other trading venues. The FTSE/Mondo Visione Exchanges Index enables investors to track 19 publicly listed exchanges and trading floors and provides a reliable barometer of the performance of the exchange sector. And this barometer shows that the performance of the sector has been very sunny.

Since inception in August 2001, the FTSE/Mondo Visione Exchanges Index has increased by about 738%, whereas the FTSE All-World Index increased by only 69%. Also, it appears that exchanges will rise faster in a rising market – during the first nine months of 2007, the World Index rose by 22.1% whereas the Exchanges Index rose by 81.1%. However, the recent subprime crisis has (at least, up to the end of February 2008) hit the Exchanges Index harder than its more general cousin.

This remarkable growth has been a tribute to the effectiveness of the new management of these exchanges, as well as the foresight of those who recognised the value locked into those members’ clubs. It remains to be seen how this sector, like others, will cope with the current chilly economic climate – but the transformation has been successfully accomplished.

Herbie SkeeteManaging director,Mondo VisioneEmail: herbie.skeete@mondovisione.comTel: +44 (0)20 7404 1940

PLEASE ENTER YOUR DETAILS TO WATCH THIS VIDEO

All fields are mandatory

The Banker is a service from the Financial Times. The Financial Times Ltd takes your privacy seriously.

Choose how you want us to contact you.

Invites and Offers from The Banker

Receive exclusive personalised event invitations, carefully curated offers and promotions from The Banker



For more information about how we use your data, please refer to our privacy and cookie policies.

Terms and conditions

Join our community

The Banker on Twitter