MEMX: Existing Stock Exchanges May Have to Watch Their Backs
Word on Wall Street is that the launch of a new stock exchange, coined Members Exchange (MEMX), is being backed by nine financial powerhouses: Charles Schwab Corp, Bank of America Merrill Lynch, E*TRADE Financial Corp, UBS, Virtu Financial, TD Ameritrade, Fidelity, Citadel, and Morgan Stanley. Some of Wall Street’s most prominent banks and brokers are on board with reducing the overall costs of trading and challenging the entrenched dominance of Nasdaq and the New York Stock Exchange. Motivation for this endeavor is rooted in longstanding resentments with the stock exchange system. Leading exchanges charge market makers and brokerages exorbitant costs in order to access data feeds that play an integral role in monitoring stock prices. In addition to data fees, financial players are charged for physical proximity to exchange computers. Stock exchanges, in response to Wall Street’s protests, claim that data revenue is a trivial portion of the $25.8 billion of trading revenue that was earned by the top five investment banks in the first three quarters of 2018. The president of the NYSE, Stacey Cunningham, contends that NYSE’s annual market data revenue, which amounts to $200 million, is “a minuscule fraction” of aggregate trading revenues (Fonda 2018).
The exchange business, which is dominated by a few powerful players, is rather oligopolistic in nature. The owners of the New York Stock Exchange, Nasdaq, and Cboe Global Markets account for approximately two-thirds of daily trading in U.S. equity markets. According to research by TABB Group regarding the market share of the exchange business, NYSE ranked first, dominating nearly one-quarter of the market, while one-fifth went to Nasdaq. IEX Group was the next-closest exchange player, which was founded in 2012 as a means of mitigating the effects of high-frequency trading. Due to their power, existing exchanges are able to continuously increase the price of access to these data feeds, thus providing a lucrative source of revenue for the exchanges but alienating Wall Street’s key financial players. Vlad Khandros, the Global Head of Market Structure and Liquidity Strategy at UBS, explains that “the level of frustration was just so high for many of us that we had to go do something more proactive for us and our clients” (Egan 2019).
According to a recent press release, the mission of MEMX is “to increase competition, improve operational transparency, further reduce fixed costs, and simplify the execution of equity trading in the U.S.” (Franck 2019). The new exchange is designed to represent the interests of its founders’ clients, which are primarily institutional and retail investors. The launch of MEMX signals a shift towards inexpensive and no-fee investing alternatives within the exchange system.
MEMX’s creation is not the first time that key players in the industry have tried to challenge existing exchanges’ power. In 2009, a group consisting of Deutsche Bank, Citi, Credit Suisse, Merrill Lynch, Lehman Brothers, and Morgan Stanley supported a low-cost exchange, termed “BATS.” During this time, other giants launched Direct Edge, an exchange that had the similar goal of lowering trading fees. BATS and Direct Edge, after gaining substantial market share, merged and were acquired by Cboe Global Markets. More recently, in 2018, the U.S. Securities and Exchange Commission requested that stock exchanges defend hiked costs for public market data. By the same token, in May of 2018, the SEC made the unprecedented appeal of two data price changes for public feeds for securities listed on the New York Stock Exchange and Nasdaq. Exchanges contend that rising data costs are the result of users’ demands for detailed, faster trading information and market fragmentation. They also argue that due to surveillance, exchanges maintain a level of market integrity that justifies high data costs. Despite these defenses, brokers continue to gripe about alleged abuses of power within the exchange system.
The desire for reduced transaction fees reflects a time when established stock exchanges were owned by their shareholders, rather than functioning as publicly traded corporations that put profit before customers’ interests. For the past decade, brokers have criticized the steep prices for market data, a service that is indispensable for all traders. MEMX allows banks and brokers to send orders to an exchange that they own, thus greatly lowering trading costs. While many of these financial firms own dark pools—private exchanges for securities trading—a new public exchange such as MEMX will increase transparency and challenge established exchanges such as Nasdaq, NYSE, and Cboe Global.
While Nasdaq reportedly welcomes the competition and is “keen to learn about the value proposition of a new exchange,” MEMX may pose a larger threat than imagined. As the launch nears, the impact on the existing exchanges is palpable. In fact, shares of the company that owns NYSE, Intercontinental Exchange (ICE), have fallen approximately 4%, to $72.45, while the stock of Nasdaq has slid about 2.2%, to $79.97. Cboe Global Markets (CBOE), the second-largest operator of U.S. stock exchanges, experienced a 6% drop in share price, to $92.80 (as of January 10, 2019). Patrick O’Shaughnessy, a Raymond James analyst, projects that the earnings at risk for Nasdaq, Cboe, and ICE are 26%, 23%, and 11%, respectively. However, O’Shaughnessy is convinced that MEMX’s impact on established exchanges’ bottom line will not be felt for quite some time, considering MEMX is still in the beginning stages of development. Moreover, Ken Hill, an analyst at Rosenblatt Securities, notes that the brokers backing MEMX will continue to pay existing exchanges in order to co-locate data center computers and access proprietary data. Therefore, Hill claims that despite MEMX’s movement towards launch, he will not change his hold on Nasdaq or buy rating on Cboe and ICE.
MEMX has raised $70 million in its initial stages of funding and is planning to submit paperwork to the SEC early this year, seeking approval to become a national securities exchange. Although the company has trademarked its name and has been incorporated, it has faced obstacles in finding an office location and recruiting employees. As a matter of fact, MEMX was trying to recruit the president of its aforementioned rival, IEX: Ronan Ryan. However, despite IEX’s insignificant market share of 2.6 percent, Ryan declined the offer. While MEMX’s value proposition is sound, it may be more difficult to gain market share considering the hyper-competitive atmosphere of U.S. markets. Even if MEMX is not able to challenge Nasdaq, NYSE, and Cboe, it is possible that its launch could pressure intraday pricing for these exchanges. MEMX’s impact on the exchange oligopoly is all speculation at this point, for the trading venue has not yet come to fruition. Regardless, existing exchanges are awaiting its launch, prepared to protect their market share.
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Baker, N. (2019, January 7). New MEMX stock market to take on NYSE, Nasdaq, CBOE; Citadel Securities among founders. Chicago Tribune. Retrieved from https://www.chicagotribune.com/business/ct-biz-new-stock-market-citadel-20190107-story.html
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Franck, T. (2019, January 7). Shares of NYSE owner fall as Morgan Stanley and Fidelity plan rival exchange. CNBC. Retrieved from https://www.cnbc.com/2019/01/07/ice-nasdaq-shares-tank-as-wall-street-giants-plan-rival-exchange-memx.html
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Stafford, P. (2019, January 9). MEMX turns up the heat on US stock exchanges. Financial Times. Retrieved from https://www.ft.com/content/4908c8b0-1418-11e9-a581-4ff78404524e