By John D’Antona Jr.
With the New Year upon the equities market, there will also be a new equities marketplace.
Members Exchange, or MEMX, has been announced by a consortium of nine financial services firms, including retail-focused powerhouses Fidelity, Charles Schwab and TD Ameritrade. The U.S.-based MEMX will be owned entirely by its founders: Bank of America Merrill Lynch, Charles Schwab, Citadel Securities, E*TRADE, Fidelity Investments, Morgan Stanley, TD Ameritrade, UBS and Virtu Financial.
“The founding members of MEMX represent leading retail brokers, global banks and financial service firms, and market makers – a diverse array of market participants organizing for the common goal of improving markets for retail and institutional investors,” said Douglas Cifu, CEO of Virtu Financial, in a released comment. “The launching of MEMX is a testament to the market-wide demand for competition, innovation, and transparency.”
The new exchange looks to crack into a market already dominated by the U.S.: Intercontinental Exchange (ICE), Nasdaq and CBOE as well as IEX.
MEMX will file for SEC approval in early 2019, the press release said.
In a statement, Members Exchange said its goals include lowering costs, increasing competition, boosting transparency and simplifying the trading process. In its announcement, MEMX said it will offer a “simple” trading model and a “low-cost” fee structure.
But does the equities market need yet another exchange?
In this era of fragmentation, internalization, off board trading and dark pools totaling over 40 venues in which to trade, can MEMX add something to the current market structure?
Aite Group capital markets analyst Spencer Mindlin recounted that over the past 20 years the market has been through two major arcs of modern market fragmentation and consolidation in the U.S. exchange industry. Demutualization kicked it off by thrusting exchanges at odds with their members. The first round was fought in the late 1990s and early 2000s, and pitted ECNs with electronic markets like Island against the incumbent exchanges.
Then, in the mid- to late-2000s, BATS and DirectEdge gained significant market share by offering market models that catered to the next generation of market makers, high frequency trading firms. Each time a new entrant was successful, it was in part because its interests were in line with their members and also because they had members represented in their cap table. The market has now consolidated itself down to three major exchange groups, with one independent exchange and a load of ATS and dark pools, all competing for market share.
So, is it déjà vu all over again?
Given the IEX exchange application approval, the introduction of a new exchange application should be no surprise. Faced with declining trading revenues and increased competition, exchanges have turned to price gouging the costs of data and technology.
“So, their customers have become very price conscious and vocal,” began Mindlin in a conversation with Traders Magazine. “The SEC has often found itself forced to referee law suits and administrative proceedings brought by firms filing suit against exchanges over unfair and unreasonable charges. And while it seems like the issues with access fees are mostly behind the industry and the upcoming access fee pilot will stick a fork in them, this most recent debate is more focused on market data and technology fees. The nuances and complexities of the fee schedules can get complicated, despite the best efforts by some CEOs to dumb it down through show-and-tell of networking equipment and an explanation of their cost during recent SEC-hosted industry roundtables.”
It may look like a rinse-and-repeat exercise when a consortium of banks, brokerages and high-frequency trading firms band together to launch a new U.S. exchange like MEMX, he continued. But the market’s structure is very different than it was the last two times. With round one, the government was intervening to break up of a monopolistic market structure that lacked technological innovation. The marketplace had a kaleidoscope of participants providing supply of and demand for order flow. During the second round, during a period of rising markets and volume there were dozens of new and sophisticated liquidity providers looking for a platform to trade since the incumbent exchanges couldn’t keep up. The contour of participants have continued to change since then. There are now less banks, and the ones that remain have almost all exited primary market making businesses. The HFT industry has changed too; profits have normalized and there are only a fraction of firms that remain with the speed and scale to survive.
Can MEMX work?
“I think MEMX has a good chance of winning market share from the incumbent exchange groups,” he said. “This new consortium-owned exchange by nine firms is very much being led by Virtu and Citadel, who together control about 40% of order flow in US markets. He who controls the market’s liquidity, controls the market. So, with the members as owners of MEMX, the exchange should be able to build the market and fee structures in their image. On the surface, it seems like the owners are in good positions: start a new exchange, route your order flow to it; maybe you exit, maybe you don’t. Still, MEMX might really just be a bluff by its owners to try and force the exchanges’ hand and come to terms with reduced pricing – a metric that would also allow the members to declare victory.
But, Mindlin cautioned that the market has seen other consortium-owned exchanges and venues try to enter and fail. While it’s not expensive to build exchange technology any longer, it is risky to run an exchange and can get costly to manage over the long-term, he noted. Large competitive financial institutions almost always find it very challenging to collaborate. And the exchanges have gotten much more savvy than they were when they found their market shares picked off by DirectEdge and BATS.
“I suspect the exchanges will be much tougher this time and are better prepared to defend their positions,” Mindlin said. “Cost pressure is being felt all around, but some firms in the supply chain just refuse to budge. This is not the first attempt by the banks and brokers to lean in on the supply chain around them. We’ve seen the large consortium play with banks firing shorts across the bows of incumbent providers before. One recent example that comes to mind is Symphony, also consortium owned, vs Bloomberg.”
One senior trading head at New York-based broker-dealer told Traders Magazine that a new exchange was always welcome in that new entrants can stimulate competition and lower data fee costs. But again, a new exchange means new costs to connect.
“It’s great to have another venue out there. We have not seen revenue dropping with regards to connection costs and data fees on their standpoint,” said the trading head. “What you could wind up seeing is ICE and Nasdaq change their models and allow for the buyside to connect in without using a broker dealer like MEMX is proposing. This, in effect, could increase pressure on the brokers margins.”
