The Infrastructure Play
Having built out huge data centers for high-speed traders to colocate their automated trading models, exchanges also are poised to capitalize on renting out their infrastructure. "They have a tremendous amount of fixed costs," says Baruch College's Donefer, who suggests that renting out the cloud is a way to amortize those costs. However, infrastructure is a commodity and there are other places to buy it, he warns.
Even though infrastructure may be a commodity, as regulations pile up and brokers face more requirements for data storage, exchanges can offer technology-based solutions that meet their customers' security requirements. Last year, Nasdaq OMX launched FinQloud, a secure cloud-computing platform, powered by Amazon Web Services, designed for financial services firms. Nasdaq OMX has signed up 19 financial clients, including Jordan & Jordan, a consulting firm that provides a trade execution analysis and compliance services to the buy side. In August, Jordan & Jordan chose FinQloud to store an enormous growing pool of quote and trade data.
"Cloud is a very inexpensive storage mechanism, and Amazon can offer that," says Rosenblatt's Shah. While firms don't have to go to Nasdaq for cloud services, and can go straight to Amazon, this still requires them to have personnel and systems to manage their data for them, says Shah. "And when the time comes and regulators are knocking on the door, you will need a staff," he says. "Nasdaq gives you the ability where they will manage it for you, so you don't have to have the staff and resources to do it yourself," he says.
But should exchanges also be running technology businesses? Is this a distraction from their core mission of running an exchange? Some critics maintain that exchanges are competing with technology vendors and market data providers and question whether there are conflicts of interest.
Despite the claims that exchanges are lowering costs, they're wearing multiple hats and increasing fees, as well. "Exchanges are raising those [market data] fees," says ACTIV Financial's Piasecki. Customers are paying 100% increases on content sets, he says, adding, "Smaller customers are finding these prices outrageous. That has created ill will."
In addition, exchanges conduct audits of the brokerage's people and technology reviews, which cost firms money to prepare reports. "It's expensive," Piasecki says.
"Licensing of exchange matching technology is kind of a no-brainer," comments Rick Lane, CTO at Trading Technologies, a provider of a derivatives trading platform with connectivity to global exchanges. It also helps exchanges standardize on the same platforms. "The more homogeneity we have across exchanges, the easier it makes for vendors to interact with them," says Lane. "But it's not necessarily going to be a true differentiator and it requires a significant investment, so finding other revenue streams makes sense." In contrast, the CTO singles out FinQloud as a unique offering apart from licensing risk management technology or matching engines to other exchanges.
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"What I find most interesting are the full-out cloud offerings like FinQloud -- they are the first big movers of a trend we're seeing -- leveraging cloud technology not just to store transactional level data or compliance audit level data, but eventually to tap into that data and gain insights into it," says Lane. They're also trying to open up that cloud framework as a marketplace to let third party vendors tap into that, he says.
But is this diversification a distraction for exchanges? "It could be a distraction because the margins are not very high initially and it's easy to catch a cold in the software business," says Sandler O'Neill's Repetto, noting that traditionally these businesses are very cost heavy, and it's easy for software projects to overrun. "The revenues are high but the margins aren't," he says.
What if exchanges offer discounts on trading fees to customers who bought their technology? After all, exchanges pay rebates to electronic market makers and HFT shops to attract liquidity and grow market share. According to Ottersgård, there are no discounts on technology services. "If you are a client, can you get a reduced fee? That would be bad from a competitive standpoint," he says. "We sell the technology and it's a business on its own, and we have a transaction business and it's priced on its own -- and we don't combine the two," he said. He also points out that Nasdaq OMX delivers technology to anyone who is willing to pay for it, even competitors who are in the exchange business. For instance, direct competitors such as BATS use Nasdaq OMX surveillance for equities and NYSE Euronext in Europe uses the same surveillance technology.
"I think it's generally good for people to have exchanges innovating," says Trading Technologies' Lane. "If they can make the data usable to the market participants, that would be beneficial. At the end of the day, the more enticing Nasdaq and NYSE can make their package, the more enticing it will be to trade their markets."
Going forward, analysts expect exchanges to keep growing the non-transaction side of their businesses. Right now exchanges earn around 25% of their revenues from transaction fees, according to Rosenblatt's Shah. "The global technology business could outgrow the transaction business," says Nasdaq OMX's Ottersgård. Recently, Financial News reported that Nasdaq OMX is hiring a head of technology sales to get to $1 billion in revenue. According to a Nasdaq spokesman, Financial News picked up an old post placed from recruiter Hedrick & Struggles that was putting feelers out. The position was not filled.
As they expand into technologies areas such as cloud-based products, exchanges must continue to innovate in their matching engines and risk management. "The area they can't be distracted in today is to make sure they're doing everything in their matching engines to stay ahead of the curve in terms of risk management," says Lane.
Juggling multiple roles, exchanges have many tentacles and are expanding in new directions. They are no longer just matching buyers and sellers of financial instruments, but selling software, data and cloud computing to brokers, hedge funds and corporate issuers. While the jury is still out on whether these measures have been successful, most everyone agrees that diversification is a winning strategy and should bring stability to the bottom line. In the volatile world of high-speed trading, the role of an exchange keeps evolving.