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Cisco: Exchanges Need to Become Tech Vendors

  • July 21, 2008
  • Mayur Pahilajani

To diversify revenue streams as they face growing competition from alternative trading systems (ATSs), exchanges must actively develop and market technology products and services, according to a Cisco Systems report being released today.

“A perfect storm of factors is now reshaping the global securities industry, and the traditional exchange trading business more than any other segment,” says the study. Demutualization, mergers, fragmentation of liquidity, new trading venues and the growth of electronic trading have produced “a near free-for-all, where almost everyone competes with everyone else.”

Peter Robin, senior director of Cisco’s Internet business solutions group and co-author of the report, said in an interview that exchanges “have been spending a lot of time improving liquidity and attempting to reduce the cost of transactions for their members and users.” They can leverage that technology by packaging and selling it to their members, added Robin, who cited the London Stock Exchange’s (LSE) iBus middleware product as an example.

The Nasdaq Stock Market sought to broaden its technology offerings with the acquisition of OMX Group, which supplies technology to 60 exchanges around the world. OMX has “developed a wonderful understanding of all the different trading venues and what the requirements are and how the technical advantage can be obtained by different locations,” said Robin.

NYSE Euronext has an emerging commercial technology business, LSE has provided technology to the Johannesburg stock exchange and the Irish Stock Exchange uses a trading platform from Deutsche Borse, he noted.

For the study--“The Competitive Landscape for Global Exchanges”--Robin and Cisco VP James Greene interviewed 40 senior executives at exchanges, ATSs and buy- and sell-side firms including NYSE, LSE, Deutsche Bourse, Credit Suisse, Goldman Sachs and Morgan Stanley.

The global battle for order flow is likely to intensify, said Robin, with the potential for 75 new trading platforms in Europe alone. Though “traditional exchanges may supply technologies to these new entrants,” there is also “a great risk of having their lunch eaten” by the new venues, which is a major topic of discussion among exchange’s boards.

The U.S. and European exchange are ahead of the curve in providing technology, said Robin, but some in the emerging markets, such as the Mumbai Stock Exchange and Singapore Exchange, are also getting into the business.

“Exchanges, the ones that will go forward and compete better, have realized that you cannot just focus on trade execution,” said Joe Rosen, president of consultancy RKA and former managing director of trading technology at NYSE. Those that do not adapt to the new paradigm will close or be swallowed up by more tech-savvy players, said Rosen, who wrote the forward to the Cisco report. “The Boston Stock Exchange had a trading engine and a number of brokerage customers, but they still could not get the revenues,” he said. “The Philadelphia Stock Exchange, which was one of the oldest stock exchanges,” will soon be part of Nasdaq.

The Cisco report also urges exchanges to reduce fees, improve speed and offer better connectivity tools. One value-added service exchanges have been providing is collocation, which improves the transmission time between venues and their members. “The idea is to put as much relevant processing as close as possible to the exchange, maybe even in the data center of the exchange itself, and as little as possible on your own premises if you are a member or an investment bank,” says the study.

Dushyant Shahrawat, analyst at Needham-based TowerGroup, agrees that “there have been some dramatic changes over the last three to four years in the exchange industry. They have gone through more changes than they have gone through over the last hundred years combined.” The drive to find new revenue sources is due partly to traditional streams drying up, added Shahrawat. Listings are increasingly going to places like Hong Kong and aggressive market centers are forcing exchanges to reduce trading and other fees. “Market data is practically free these days,” he noted.

Today, about one-tenth of the world’s exchanges are selling technology, said Shahrawat, but by 2010 almost 80 percent will be in the business. “Most of the major exchanges will make 40 percent of their revenue from some sort of technology services sales,” he said.

However, it’s not an easy market to enter, said Sang Lee, analyst at Boston-based Aite Group. “Just because you have the technology doesn’t mean that you will be able to sell it to other players.” Success requires a considerable investment, market expertise and a favorable regulatory climate, noted Lee. “Generally small to midsize exchanges have a hard time moving in this direction,” he said.

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