In the lull before London and New York packed up for Christmas, BATS Exchange, the ambitious four-year-old trading venue that has rapidly become the third largest exchange in the US, announced its intention to enter the listings business. The move will once again pitch the disruptive upstart directly against NasdaqOMX and NYSE Euronext, the old men of Wall Street who dominate both the domestic and international initial public offering (IPO) business.
But BATS is not the only trading venue eyeing the listings business. According to the head of electronic equities at a major US retail broker, listings will become the next battleground among the top US trading venues. Nasdaq, which in 2008 far outgunned its arch-rival NYSE with 2952 listings versus NYSE's 1963, announced in October 2009 its intention to launch a new listing market, Nasdaq BX, which aims to capture listings from companies that would not otherwise qualify for its well-established Nasdaq Stock Market or for NYSE's celebrated Big Board.
Jersey City-based Direct Edge, meanwhile, is awaiting Securities and Exchange Commission approval to become an exchange and many onlookers expect the highly successful trading venue, which commands a share of about 12% of US equities trading, to expand into listings in due course. Bill O'Brien, CEO of Direct Edge, does not rule it out. "It is something that we continue to contemplate," he says.
For BATS, the move into listings makes strategic sense. If nothing else, it cements the BATS' status as an exchange, which it acquired in August 2009, and throws off its image as little more than a transaction service provider. It is also no secret that BATS is determined to pressurise the lumbering, flabby Wall Street incumbents and the IPO business is not an insignificant pressure point: it constitutes one of just three or four revenue streams available to exchanges, along with trading fees, market data and technology services.
Like its competitors, however, BATS also needs to diversify its income stream, particularly as the pricing war in the equities trading business has suppressed revenues and BATS does not offer technology services or charge for data. Moving into listings is a necessary if awkward move, say market-watchers. "It is hard for an exchange to ignore the listing business since they have a very limited means of making money," says Larry Tabb, CEO of capital markets analyst firm Tabb Group.
But can challengers such as BATS and Direct Edge in the US, or even Chi-X in Canada and Europe, all regarded as technological innovators, hope to make inroads into the high-touch, soft-skilled, 'wine-and-dine' business of courting listings? Or has the cannon of 'faster, cheaper, better' reached its limit?
Shifting priorities
Fragmentation in the US and European equities markets has rendered the location of a listing all but irrelevant from a liquidity perspective: NYSE, for example, trades less than 40% of the daily volume in its own listed names, suggesting that there is no longer a direct relationship between the location of a listing and liquidity in that stock. "As a result, the venue on which a company is listed becomes less and less important," says David Weild, a capital markets advisor at consultancy Grant Thornton and formerly vice-chairman and executive vice-president of new listings globally at Nasdaq. If liquidity is not an issue, which factors determine where companies list?
Price has undoubtedly proved a critical differentiator in the secondary markets. But it is less clear that cost is a competitive factor in the primary market: is it enough to undercut the incumbents? The answer is a resounding no. "Companies do not join a market because of the listing fee. It is about being the right market to operate on," says Rachel Maguire, head of strategic development at Plus Markets, the London-based stock exchange for small and mid-cap stocks. Although BATS' business plan for its listings product is not yet concrete, the company's CEO, Joe Ratterman, agrees that cost will not prove a major driver for most firms. "Our cost, relative to our competitors, may be somewhat advantageous, but it will not be the lead for us," he says.
But if pricing is not an effective means of entering the market, challenging the powerful brand recognition commanded by Nasdaq and NYSE will prove practically impossible. Branding is of paramount importance in the listings business, say market watchers, and a lack of brand recognition will prove a glaring weakness for any new entrant. Equally as obstructive is the immense cost associated with building and maintaining that brand. The marketing and publicity services typically included in a listing deal with NYSE or Nasdaq could be worth in excess of $300,000 - a sweetener that young, lean upstarts would struggle to match.
For this reason, economies of scale are vital, says Mr O'Brien, who formerly ran new listings at Nasdaq. "The nature of the business is that it is very healthy and profitable, but only if you have scale, particularly in a competitive environment." Although Mr Ratterman concedes that the limited breadth, if not the quality, of the BATS brand is problematic, he believes that there is an appetite in the market for an "interesting alternative" with a different operational style. BATS is a no-frills outfit headquartered in the US's Midwest and, as such, may prove attractive to companies located outside the New York-centred East Coast orbit, he says.
Perhaps more convincingly, however, Mr Ratterman argues that the present duopoly does not satisfy all issuers' needs. "Issuers have a broad range of needs, but because NYSE and Nasdaq have been the only choices, they have won all the deals. But if you break the issuers' needs into a spectrum, somewhere along that spectrum their needs may not be perfectly aligned with the products provided by NYSE and Nasdaq. So I would say we have an opportunity to compete with them." A more "personal" service, as Mr Ratterman calls it, or at least customised approach may well transpire to be the savviest point of entry. The likes of BATS and Direct Edge may also be able to bring their technical expertise to bear in this space: data services, analytics and insight into trading activity of an issuer's stock could prove attractive enhancements to the existing listing product.
Joe Ratterman, CEO of BATS Exchange
Small concerns
Brian Taylor, the managing director of BTA Consulting and formerly the CFO of Plus Markets, agrees that the listing product, in so much as it is "stale" and overly compliance focused, is "open to be reinvigorated". But any innovation should be sector focused; the small and medium-sized enterprise (SME) market is particularly overlooked, he adds. "The SME level is where new entrants could really innovate," says Mr Taylor. In the US, SME and micro-cap companies are particularly poorly served by the one-size-fits-all model, says Direct Edge's Mr O'Brien - an observation borne out in recent research by Grant Thornton. In the firm's November 2009 report exploring the so-called 'Great Depression in Listings', the writers claim that a long-term structural shift in the US equity markets is destroying the ecosystem that supports small-business formation. Small IPOs from sources including venture capital, private equity and private enterprise are "all nearly extinct and have been for a decade", says the report.
The situation is not much better in Europe. Anne Glover, CEO of London-based venture capital firm Amadeus Capital Partners, agrees that small companies are "dreadfully underserved" and adds that for some SMEs that do launch an IPO, a subsequent lack of activity in the stock renders the listing of "absolutely no use". To the extent that a new entrant in the listings space might be able to take a different approach, providing support and adding value and visibility to the listing, there may be opportunity in this sector, according to some. But Ms Glover questions the extent to which a listings venue could achieve this, adding that it is up to the broker community, not the exchanges, to generate interest in smaller stocks.
Nonetheless, Nasdaq's move to open an SME-focused listings venue seems an acknowledgement of the deficiencies in this sector, while the success of the Toronto-based TMX Group's Venture Exchange underlines that there is success to be had through the right offering. Furthermore, neither Nasdaq nor NYSE have the overweening brand strength in the SME space that they boast in the large-cap market which would help to lower the barriers to entry. And while Direct Edge's Mr O'Brien is non-committal about his company's plans where listings are concerned, it seems that the small and micro-cap segment would be the most likely candidate, should the company launch a listings business. "The only way we would consider entering the business is if we could provide a level of innovation to a community that I feel is underserved," he says.
For Mr Ratterman, however, SMEs and micro-caps do not appeal. In the first instance, BATS will focus on new listings in the mid-cap and above range, he says, including start-ups, as well as exchange traded funds (ETFs). The latter will be easier to target as ETF issuers are less fussy about where they list their products and are more concerned with cost, says Mr Tabb. But most observers agree that the listings business may prove the greatest challenge yet for BATS and its peers.
