Exchanges - Strategic Options for the Future

Executive Summary

The world’s exchanges are one of the bright spots in capital markets and investment banking, with total revenues growing and expected to exceed US$20 billion in 2016. Profit margins for exchanges remain remarkably high, with an average of about 60% for leading exchanges.

The rosy statistics for the industry mask astonishing differences in performance, with the best exchanges almost 100 times as efficient as the weakest players. Only about half of these variations in efficiency can be accounted for by scale or transaction volumes. The most effective exchanges, BATS and Australian Securities Exchange (ASX), boast costs of only about $0.03 per equities trade, while the Spanish and Swiss exchanges occupy the unenviable opposite end of the spectrum with an awful $1 and $2 per transaction respectively.

The drive for cost savings and dominance in the past decade has brought a bewildering range of mergers amongst exchanges, and we expect this trend to continue in the coming years, as they seek to diversify their revenue bases both geographically and by product offerings. However, the major rationale for mergers is to achieve greater economies of scale by driving greater trading volumes through exchanges’ infrastructures.

There are various strategies for future success, with mergers a top choice for exchanges attempting to continue to reduce their operating costs and diversify their revenues. However, not all mergers are paying off. Our view at Opimas is that there are more creative strategies that exchanges should consider, which involve moving more aggressively into the space occupied by banks and securities firms. To do so, exchanges may have to overcome a deference to the sell-side, which formerly owned them. This makes them approach competing with broker-dealers with almost excruciating trepidation.

Figure 1. Exchange Revenues, Profit Margins and Growth Rates

Source: Exchange filings, Opimas Analysis 

Another interesting option for exchanges is the area of inter-dealer brokers and a push into over-the-counter derivatives. While an increasing portion of inter-dealer activity is based on electronic trading, employing a model very similar to exchanges, the potential for value creation is higher in products that are still largely traded by voice. A push into these voice-traded businesses would be a departure from exchanges’ traditional strategies, but one well worth considering.

Moving forward, we expect exchanges generally will continue to flourish and form one of the few bright spots in capital markets. However, it won’t be plain sailing for exchanges to hold onto their pricing power. The sell-side is experimenting with cheaper alternatives to trading. Leaner, upstarts could take market share, and European regulators have ruled that fees for the fast-growing business of providing market data must be “reasonable.”


This report provides an overview of the exchange industry and analyses the current state of derivatives and equity exchange around the world, highlighting differences among the stronger and weaker players. In addition, we examine what trends are likely to shape this market in the coming years.

Overall, exchanges find themselves in remarkably robust health, with strong profit margins and appealing prospects for the coming years. This report examines the plethora of mergers that have characterised the last decade and a half including some that have been problematic,  and scrutinises the rationale behind these mergers. We also review exchanges’ financial positions and their varying sources of revenue.Finally, the report examines future possibilities, including continued cost cutting through mergers, but also expansion into other areas that exchanges have historically been reluctant to engage in. Namely we advocate a more aggressive push into the areas traditionally occupied by sell-side institutions.

The Quest for Size

The Rationale for Merger

Over the course of the past fifteen years, there has been a bewildering array of mergers amongst exchanges. A selection of the most important transactions is shown in Figure 2, which gives an overview of activity from 2000 to the end of 2015. We should point out that this does not only include exchanges, but also trading platforms that provide a function similar to exchanges. Generally speaking, there are three motives driving these mergers and acquisitions:

  • To gain economies of scale in a single asset class. Most of the mergers shown in Figure 2 fall into this category. A quest for scale efficiencies is the logic underpinning the creation of exchanges such CME Group, Euronext, or Nasdaq OMX. We discuss the performance of the merged companies in the next chapter.
  • Defensive acquisitions to retain market share. On occasion, innovations in technology or shifts in regulation have allowed new entrants to capture significant business. When that happens, the incumbents, frequently slow to adapt, have been forced to make costly acquisitions or run the risk of obsolescence. This was true of Nasdaq’s acquisition of Inet, and NYSE’s acquisition of Archipelago, both of which had made significant inroads into the acquirers’’ businesses.
  • Cross-asset class expansion. A number of mergers have involved equities and derivatives exchanges acquiring platforms that also trade products such as currencies or fixed income securities. Typically, this does not bring significant economies of scale, but can lead to advantages in cross-selling, and, in the future, opens the possibility of providing more integrated cross-asset orders.

Figure 2. Mergers amongst Exchanges

Source: Exchanges, Press, Opimas

Scale and Efficiency

As we noted, one of the most compelling reasons for exchange mergers is to pursue greater economies of scale. Exchanges have significant fixed costs, and increased volumes can easily decrease the operating cost per transaction. An examination of the cost per transaction for different exchanges compared to the number of transactions in  Figure 3 reveals that there are indeed very significant savings. The most efficient, and generally largest, exchanges have operating costs per transaction almost two orders of magnitude lower than the least efficient, and generally smallest, exchanges.

Almost half of this variation in efficiency among exchanges simply comes from the number of transactions passing through their platforms. However, volume is not the sole determinant of efficiency, and a variety of other factors specific to each exchange come into play.

Exchanges with the lowest costs, BATS and Australian Securities Exchange (ASX), spend only about $0.03 per equities trade, while the Spanish and Swiss exchanges occupy the unenviable end of the spectrum with an awful $1 and $2 per transaction respectively.

The log-log plot of the data on the right side of Figure 3 readily allows a comparison between a particular exchange’s cost efficiency and its trading volume. The poor performance shown by SIX can only partially be explained by the fact it is the smallest exchange in terms of volume in our sample. Given SIX’s scale, a cost per transaction of about $0.70 should be achievable – a third of the actual cost. Clearly, factors other than just size have significant impact on the exchange’s efficiency.

Figure 3 does reveal some surprises and allows us to categorise the exchanges in three ways, with operating costs that are:

  • Better than expected, including BATS, ASX, TMX, and the Moscow Exchange.
  • In line with expectations. ICE (NYSE) BM&FBOVESPA, JPX (Tokyo SE), Deutsche Börse, HKEX, and BME fall into this range.
  • Worse than expected, including Euronext, Nasdaq OMX, London Stock Exchange, and SIX Swiss. All of these exchanges should be able to reduce their operating costs by at least 40% based on their volume of transactions

Figure 3. Scale Curve for Equities Trading

Source: Company financial reports, Opimas Analysis

Revenues and Profits

Industry Revenues

Overall, exchange revenues continue to grow, and we expect the industry to exceed US$20 billion for the first time in 2016. In Figure 4 we show the global revenues in the exchange industry, broken down by lines of business. However, underlying the smooth progression in industry success, there are some significant differences in individual lines of business.

The strongest growth is visible in the business of providing  market data, the only segment showing double-digit growth. This reflects exchanges’ deliberate strategy to move away from transaction-based fees that are highly cyclical to more stable subscription-based revenues. In addition, outside of the US equities markets, exchanges have what almost appears to be monopoly pricing power over their data – market participants currently seem to have no choice but to buy the dominant exchange’s market data, giving the exchange considerable latitude in price setting.

Figure 4. Exchange Revenues by Product Line

Source: Opimas Analysis

In US equities markets, by contrast, regulators have long set up market data plans, including a consolidated tape, that determine the revenues generated from market data. In Europe, new regulation in the form of MiFID II specifies that market data fees must be “reasonable” starting in early 2017, but provides no further guidance yet on how to determine reasonableness.

Figure 5. Revenues for Leading Exchanges 2012-2015

Source: Company financial reports, Opimas Analysis

Outside of market data, derivatives trading and clearing continue to show healthy growth, while other products such as listing or trading of cash instruments (primarily equities) are essentially flat.

Figure 6 shows the revenue mix for the major exchange groups included in this report. With a slew of mergers between derivatives and equities exchanges, these revenues have become increasingly heterogeneous. The purest play in this sample is the Chicago Mercantile Exchange (CME) which has remained clearly focused on derivatives trading and the clearing of those instruments.

BATS stands out for its focus on equities trading, as well as options on those equities. Unlike most equities exchanges, BATS derives comparatively little of its revenues from listing equities, while some of its competitors get as much as a quarter of revenues from that business.

Nasdaq OMX is an interesting case, as the firm derives much of its proceeds by selling technology solutions, and is the leading provider of information technology platforms to other exchanges around the world.

Figure 6. Exchanges – Sources of Revenues

Source: Company financial reports, Opimas Analysis


The overall industry operating margin is astoundingly high at almost 60%, about twice the level seen in other financial services. Figure 6 shows the revenues, profit margins and growth rates for leading exchanges.

The exchanges clearly fall into different groups, with a handful showing lower profit margins. These include BATS, the London Stock Exchange, Nasdaq OMX, and SIX Swiss. For BATS, this stems from an almost anachronistic attachment to a model that largely disappeared in the rest of the industry. That is, the operation of a semi-profitable, industry-owned utility, setting its prices and policies to benefit its members. This certainly was how most exchanges managed themselves before the wave of demutualisation, which ended members’ ownership, brought a much greater focus on maximising profits. With BATS recently going public, in its second attempt, its old-fashioned  behaviour will doubtless change, as the firm will have to satisfy shareholders who will demand maximum profits.

SIX Swiss stands out as the laggard on this chart, and we have already examined this exchange’s poor operating efficiency which is at the root of this showing.

The large derivatives exchanges CME and ICE are in the enviable position of having very high operating margins, while being able to generate top-line revenue growth at the same time. However, their performance is decidedly modest compared to the Hong Kong Exchange (HKEX), which benefited from the spill-over of a huge increase in trading volumes in mainland China, while maintaining operating margins in excess of 75%. However, with trading volumes in China falling back from their stratospheric levels in 2015, a growth rate of 40% will be exceedingly difficult to replicate.

In the upper left segment, we find a number of exchanges that have impressive profit margins, but, at least in dollar-terms are shrinking. Falling exchange rates for the Brazilian real and the Russian rouble have pushed BM&FBOVESPA and the Moscow Exchange’s into negative territory, at least in dollar terms.

Figure 7. Exchanges – Revenues, Profitability and Growth

Source: Company financial reports, Opimas Analysis

Trading Volumes


Derivatives exchanges have very different fortunes. Figure 8 shows trading volume for the three major players, CME, ICE, and Eurex. These statistics include US equities options, which are usually omitted from such comparisons, because ICE and Eurex both have significant US equities options business through their subsidiaries New York Stock Exchange (NYSE) and International Securities Exchange (ISE) respectively.

Figure 8 demonstrates the diverging success in derivatives. While CME has increased its transaction volumes, ICE has lost business and Eurex has not added much. ICE has lost terrain particularly in interest-rate derivatives, losing market share to CME.

Figure 9 compares the leading three exchanges’ penetration by product types. CME stands out as deriving the largest portion of its revenues from interest-rate products, while ICE has the leading franchise in energy-related trading. Once its US subsidiary ISE is taken into account, Eurex is surprisingly heavily dependent on equity-related instruments.

Figure 8. Derivatives Exchanges Contract Volume 2012-2015

Source: Exchanges, Opimas Analysis

Figure 9. Derivatives Exchanges by Type of Contract

Source: Exchanges, Opimas Analysis


On the equities side of the house, trading in the US has largely regained the volumes seen before the 2008 crisis, as Figure 10 shows. However, Europe has not yet entirely recouped the trading revenues lost since 2007.

Figure 10. Equities Trading by Region 2012-2015

Source: Exchanges, Opimas Analysis

China’s rise to prominence in equities trading was dramatic in 2015, when it surged and became a market twice the size of Europe, only to fall back to earth again in late 2015 and early 2016. The collapse in Chinese trading devastated the Shanghai Stock Exchange, whose volumes have dropped about 75% from their  peak in  the summer of 2015.

Looking Forward

The healthy state of many exchanges, and a relatively light regulatory touch, should allow them to pursue more ambitious and daring strategies in the coming one to two years. We examine some of the alternatives in this chapter and provide an overview of these possibilities in Figure 11 on page 19.

Continued Mergers

Given the economies of scale outlined in Figure 3 on page 8, we expect exchanges will continue to consolidate, with the announced merger between the London Stock Exchange and Deutsche Börse simply being the latest in a long line. While the logic underpinning these mergers appears to be watertight, migrating to a combined platform can be fraught with difficulties. A handful of exchange mergers in the past have failed to live up to expectations as they dealt imperfectly with technical and organisational difficulties in integrating the operations.

New Entrants

In general, new entrants in the exchange market have struggled to wrest business from established incumbents. The reasons are fairly obvious: a dominant trading platform is the most likely to provide the best buy and sell prices to users as it will have the deepest pool of liquidity. Even with a better operating model, it is no mean feat to offer prices low enough to attract this liquidity to a new platform.

Clearly, there have been exceptions, and improved technologies, new regulatory regimes, different operating models, and better incentives for liquidity providers have all led to shifts in trading volumes. However, marginal improvements are not sufficient to make newcomers successful. They must make quantum leaps in economics or operating models to be effective. Many new exchanges struggling to capture market share have languished – for example, CME Europe and Nasdaq NLX have had difficulty attracting volume away from Eurex.

There are some new exchanges focused on products that existing exchanges have been reluctant to offer, such as the Hemp and Cannabis Exchange, or exchanges focused on single, exotic products, but such firms are almost by definition marginal.

A more direct challenge to established players is small upstart exchanges with operations that are radically more efficient. One example is the MIAX Options Exchange, which with only 75 employees offers a relatively complete range of services for options on US equities. Given the bloated staff running technology and operations at many larger exchanges, such new entrants have the potential to seize market share. Chief executives of older exchanges must ask themselves why they are paying technology groups with hundreds, if not thousands, of staff, when more nimble operators are delivering a similar set of services with only a few dozen developers.

Increased Competition with Sell Side

In most industries, business strategies aimed at moving up and down the value chain are considered absolutely normal. However, vertical integration of the exchanges has not come naturally. They have been extremely reluctant to trespass on sell-side firms’ territory and offer products and services that might be competitive. This is understandable given that sell-side firms are exchanges’ core customers and there are risks in offending them. However, this deference has deeper roots. The current generation of senior exchange managers came of age in a market where banks and securities firms were not only the virtually exclusive users of the trading platforms, but actually owned the exchanges.

Few member-owned exchanges remain, and those that were once operated on a semi-profitable basis for the benefit of the banks and broker-dealers who owned them are gone. However, a reluctance to alienate former members persists. Unfortunately for exchanges, this favour is not returned. Broker-dealers are constantly creating alternatives to exchanges in an attempt to reduce their dependence on them and shrink  the fees that exchanges can charge.

In the future, we expect the boundaries between sell side and exchange to blur more and more, with exchanges increasingly performing functions that have historically been reserved for broker-dealers. For example, smart order routing, already provided by exchanges for US equities, is likely to become more common for derivatives exchanges. The same is true for European and Asian equities.

There is no reason that exchanges should not offer more sophisticated orders, including algorithmic trading strategies. Indeed, some exchange-provided orders, such as iceberg trades, are essentially very simple algorithms. Programmed trades would be much easier for users to execute on an exchange than at a broker-dealer. Furthermore, exchanges could easily handle orders facilitating pairs trading, where one stock is sold at the same time as another is bought, without help from the sell side.

Exchanges could also move into multi-asset trading strategies, combining, for example, FX trades with foreign equities. With rising numbers of exchange mergers spanning asset classes, we expect more offerings of the different products available within the same exchange.

To diversify their product lines, exchanges must increasingly position themselves as alternatives to sell-side institutions. That is an uncomfortable activity for them, but considerable revenues are at stake.

Inter-Dealer Brokers

Exchanges could also benefit by taking over some of the inter-dealer brokerage business. The switch from voice brokering to electronic brokering is well advanced, and products that largely trade electronically are simple to acquire. Nasdaq, for example, bought eSpeed, an electronic platform for the trading of US government securities, from inter-dealer broker BGC Partners. Such purchases provide logical ways to expand asset classes and add volume.

More tantalising is the prospect of buying an existing inter-dealer broker with significant voice-trading activities. With such a full-blown merger the potential for value creation is much higher, but fraught with difficulties. On the positive side, a dealer’s voice brokering would contribute a host of over-the-counter (OTC) products in a market where derivatives exchanges have not made much headway. The exchange’s basic goal would be to move the dealer’s voice-traded OTC business onto an exchange-like, electronic trading platform.

In a forthcoming report, we will specify how to manage such an acquisition, which requires adequate incentives to voice brokers to move products onto an electronic platform, while keeping an eye open for more exotic products.

Figure 11. Strategic Opportunities for Exchanges

Source: Opimas Analysis


Exchanges long were somewhat of a backwater in capital markets, highly regulated and semi-profitable, operating basically as utilities. In recent years, the table has turned, with exchanges now achieving profitability well beyond the reach of most financial institutions. In terms of regulation, it is the banks and broker-dealers who have come under far greater scrutiny than exchanges. Indeed, the regulatory pressure on financial institutions has become so intense since the 2008 crisis that they have found themselves virtually unable to innovate, as they deal with one new regulation after another. Exchanges, in contrast, have become relatively free of regulatory intervention and are in a position to take advantage of this and push aggressively into territories traditionally occupied by the sell side.

In coming years we anticipate that exchanges will continue to merge, expanding their less cyclical subscription-based services such as market data, and will push into territories currently occupied by sell side firms and inter-dealer brokers. Notwithstanding the challenges, the exchange business should remain one of the few bright spots in capital markets for the next few years.

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