THE BOSTON Equities Exchange (BEX) called it quits. It was the first of the regional exchanges (dealer-capitalized or not) to throw in the towel. But what does this mean? Is the Boston Stock Exchange (BSX) dead? Is it valueless?
First, the BEX may be dead, but the BSX certainly isn't down for the count. While the options business is moving forward, there still is intrinsic value in one of its little-known and poorly understood assets -- its clearing license.
The SEC has issued only three clearing licenses -- one to the DTCC, one to the BSX and one to the Philadelphia Exchange (PHLX). While the only one that is being used is DTCC's, both NYSE Euronext and Nasdaq are eyeing these licenses closely.
To better understand the value of a clearing license (which is extremely difficult to obtain by virtually everyone's account), one must look at the U.S. equity execution business as well as a number of non-U.S. exchange models. First, the U.S. equity exchange business (not market data or listings, but matching) is not very profitable. After years of cut-throat competition from Instinet, Island, Archipelago, Brut and RediBook, the major exchanges acquired them all, only to find new competitors, such as BATS and Direct Edge, cutting fees to the bone. In some cases these competitors have adopted Crazy Eddie-style, give-it-all-away, inverted pricing schedules in which the matching entity actually loses money on shares it trades.
Clearing fees, while they have shrunk over the past few years, have not fallen like exchange execution fees or, for that matter, like the 80 percent drop brokers have experienced as low-touch commission rates dropped from 6 cents to less than 1 cent since decimalization was introduced in 2001. While it is difficult to determine the exact rates brokers pay for equity clearing, DTCC annually books more than a billion dollars in revenue. These fees are eyed enviously by the exchanges.
In addition, compared to the U.S. model, European exchanges have a vertically aligned exchange and clearing infrastructure (in which exchanges have trading and clearing performed by the same, or closely aligned, entities).
What would happen if the NYSE (or Nasdaq, for that matter) had its own clearing, settlement and depository infrastructure for NYSE-listed securities? If a buyer held the securities at NYSE, it could not sell them on a competing exchange without having to move the NYSE-domiciled securities outside of the NYSE clearing facility. This, of course, would incur an extra charge, and NYSE or Nasdaq could price these intradepository transfers uneconomically, making it virtually infeasible to trade across exchanges.
This integrated model makes injecting a competitive exchange very difficult, keeping the overall price of trading, clearing and settlement high. This linkage has made the consolidated cost of matching, clearing and settlement in parts of Europe five- to 10-times higher than in the U.S.
While this sounds nice for the exchanges, developing a competitive clearing entity in the U.S. is not a near-term reality. DTCC is currently member-owned, and trying to disintermediate the depository features out of the DTCC would be met with significant pushback. This is why the BSX and PHLX exchanges haven't developed clearing organizations and why their clearing licenses have not been sold already. It is also why we have a more efficient and effective exchange and utility infrastructure in the U.S. than in Europe. However, while the depository may be sacrosanct, that is not to say that other adjunct services in the U.S. market may not be able to be siphoned off, such as netting or other shared services. Hence the interest in both PHLX's and BSX's respective clearing licenses.
So while it may be shuttering the BEX, don't count Boston out. The closing of the BEX was a body blow, but there still may be life in that ol' Beantown exchange yet. <<<Larry Tabb is the founder and CEO of TABB Group, the financial markets' research and strategic advisory firm focused exclusively on capital markets. Founded in 2003 and based on the interview-based research methodology of "first-person knowledge" he developed, TABB Group ... View Full Bio