A trio of new competitors is pushing into the exchange business in a move that could alter U.S. equity trading for years to come.
Today, stocks and exchange-traded funds can be dealt across a wide array of trading platforms, including dozens of opaque private venues and 13 more heavily policed stock exchanges controlled by the Intercontinental Exchange Inc.-owned NYSE, Nasdaq Inc., Cboe Global Markets Inc. and IEX Group Inc.
But three companies — the Members Exchange, Miami International Holdings Inc. and Long-Term Stock Exchange Inc. — are now designing stock exchanges of their own, as criticism of the old-guard exchanges' business models is starting to boil over on Wall Street and in Washington.
"We're in a moment where I don't think there's ever been a bigger opportunity for change in the markets than right now," Brad Katsuyama, who co-founded and is CEO of the sole independent U.S. exchange operator, IEX Group, said in an interview.
IEX has been trying to break up the stronghold that NYSE, Nasdaq and Cboe have on the market since its launch as an exchange in 2016. But the trading bourse made famous by Michael Lewis' 2014 best-seller "Flash Boys" has struggled to steal market share and corporate listings from its larger foes.
Taking on the existing exchanges is no small feat, but there are big rewards if one of the upstarts succeeds.
Under a 2005 regulation called the Order Protection Rule, trade orders cannot be executed at a lower price than what is available on a U.S. stock exchange. Banks and broker/dealers have interpreted the rule, part of a broader set of reforms called Reg NMS, to mean they must connect to every stock exchange and subscribe to their trading data feeds to ensure they have a comprehensive picture of the markets,
That has effectively established a built-in revenue stream for exchange operators.
"There's a big pot of gold at the end of the rainbow," said Larry Tabb, founder and research chairman of TABB Group, in an interview.
Executives at the new ventures also say there is mounting evidence that Wall Street is looking for something different in the exchange space.
The Members Exchange, or MEMX, has zeroed in on the intensifying backlash over NYSE, Nasdaq and Cboe's market data feeds. Much of the trading community says the exchanges charge unjustly high prices for the real-time trading data banks and brokers need. The exchanges argue their data feeds' prices are warranted given the competitive environment they operate within.
MEMX was founded, in part, as a result of that conflict. Nine of the largest financial services companies, including Morgan Stanley, Virtu Financial Inc. and Citadel Securities LLC, established the venture earlier in 2019 to create a simplified and transparent trading venue. To start, MEMX will not charge for market data or connectivity in a move designed to build up its market share as the ecosystem's low-cost alternative. The exchange is working to finalize its SEC application.
"There's this feeling that there needs to be competition again," said Jonathan Kellner, CEO of MEMX, in an interview. "It's been brewing for the last couple of years."
Miami International, or MIAX, wants to deploy a similar approach in its entrance to the equity market. But the New Jersey-based company has something working in its favor that the other ventures lack: A history of running exchanges.
MIAX has three U.S. options exchanges that together handle nearly 10% of trading in that market. The company plans to launch its stock exchange in either the second or third quarter of 2020, pending regulatory approval. MIAX hopes to offer a suite of products that complement its options offerings, and eventually, break into the cutthroat corporate listings business by focusing on Hispanic companies and entrepreneurs.
"This is a natural evolution for us," Chairman and CEO Tom Gallagher said in an interview. "I'm not afraid of going into a market that is mature."
The Long-Term Stock Exchange, or LTSE, is the only one of the three whose exchange application has been submitted and approved thus far.
Regulators still have to sign off on the Silicon Valley-backed exchange's long-term-centric listing standards. But LTSE hopes to become the preferred listing venue for issuers seeking safe haven from short-term market pressures, which founder and CEO Eric Ries has said are "infecting modern capitalism." LTSE recently proposed its first set of listing standards, which would require companies to adopt and publish long-term policies explaining everything from their environmental impact to how their executive and board compensation aligns with the company's long-term vision for success.
It may not be bad news in the end for NYSE, Nasdaq and Cboe, though. All three exchanges may have a chance to snatch away a larger portion of retail order flow from dark pools and other off-exchange venues once MEMX goes live, as both Virtu and Citadel control a massive amount of retail investors' orders that could migrate onto the public markets once the venture launches, ICE Chairman and CEO Jeff Sprecher has said.
Still, the entry of three new exchanges might only worsen what some see as a trading environment already defined by complexity.
The fragmentation across venues has largely stemmed from the Order Protection Rule, which Parker Lim, head of equities strategy at Cboe, described as "the most impactful piece of regulation" in recent years. While Cboe operates four exchanges of its own, Lim said some fragmentation is warranted as long as each venue carries a "unique value proposition."
"Fragmentation for fragmentation's sake, or because our regulations make it advantageous for anyone to open a market in today's world, doesn't add value," Lim said in an interview.