The inter-play between inter-dealer brokers (IDBs) and exchanges is a topic that appears to recur on a perennial basis. These two sets of market participants play very similar roles economically – that is bringing together buyers and sellers of financial instruments. However, despite this fundamental similarity, exchanges and IDBs have very different approaches to fulfilling this function, with IDBs continuing to focus heavily on voice brokerage, while exchanges focus largely on fully electronic trading.
The economics of exchanges and IDBs are starkly different. While exchanges have seen buoyant revenue growth and strong returns, IDBs have faced strong head winds (see Opimas report Exchanges – Strategic Options for the Future). As a result, the multiples that exchanges have been able to command far exceed IDBs’. We believe that this creates an opportunity for an exchange to acquire an IDB (see Figure 1), and generate significant shareholder value - although such an acquisition is fraught with risks.
We provide an outline of a strategy for an exchange to acquire an IDB in order to minimise the risks associated with such an acquisition. Namely,
- Keep the acquired unit organisationally separate;
- Migrate flow products to electronic trading;
- Integrate the IDB’s electronic trading into the exchange’s systems; and
- Retain voice brokers for emerging products.
Figure 1 Potential for Value Creation in Inter-Dealer Brokerage Market
Source: Firms’ financial reports, Opimas Analysis