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Future growth of exchanges' key data businesses uncertain after SEC ruling

A recent SEC ruling has cast a shadow of uncertainty over the future of a key business line for the three major U.S. stock exchange operators.

In a unanimous decision, the SEC's five members said that Intercontinental Exchange Inc.-owned New York Stock Exchange and Nasdaq Inc. did not justify particular fee hikes to certain market data products, instead siding with the Securities Industry and Financial Markets Association, an industry trade group representing dozens of financial companies.

It was the latest sign that the regulator is ramping up scrutiny of a vast array of stock market data products that have fueled the U.S. exchange operators for the better part of two decades.

"It's a pretty significant challenge to the traditional exchange model that we've seen over the last 15 years," Larry Tabb, founder and research chairman of research and consulting firm TABB Group, said in an interview. "We're on a trajectory for this to be a pretty significant fight."

Both the New York Stock Exchange and Nasdaq, the named defendants in the case, said they plan to appeal the SEC's ruling in federal court. The decision, which reversed an earlier opinion by one of the SEC's internal judges, marks a "troubling shift" at the SEC, NYSE said in a statement.

For several years, banks, broker/dealers and high-frequency traders have felt compelled to subscribe to the fastest, most comprehensive trading data they can get. Wall Street companies have said the data is essential to allowing them to compete with one another and to ensure that their clients' orders are executed at the best prices.

The swelling interest in market data has led the exchanges to form core business lines around the repackaging and sale of data on the millions of equities and derivatives trades that occur on their venues. Based on revenues from the New York Stock Exchange and Nasdaq's proprietary equity data products in the third quarter of 2017, those products would have accounted for 1.9% of ICE's total revenues in 2017 and roughly 4% of Nasdaq's total revenues for the year, Jefferies analyst Dan Fannon wrote in an Oct. 17 research report.

The exchanges have consistently booked sizable fee increases on the data products, which they have said are justified due to competitive pressures. Those rate hikes, which critics have said were inflated with minimal oversight, are at the heart of the SEC case. Trading firms and broker/dealers have argued that because each exchange's feed is unique, they must subscribe to all of them, meaning that none of the feeds are subject to competitive pressure.

"For far too long, these market data fees have been left unchecked in a way that I think is not healthy for the marketplace," said Joe Wald, founder and CEO of independent broker/dealer Clearpool Group Inc., in an interview. "This recent action is a real turn in the tide." Clearpool saw a 62% increase in annual equities data expenses from the New York Stock Exchange between 2013 and 2015.

The New York Stock Exchange said it will not immediately change its feeds or their prices in response. An Oct. 17 investor presentation from Nasdaq said the impact of the SEC's decision is limited to a specific fee that generates roughly $1 million per year. Cboe Global Markets Inc., which was not a part of SIFMA's lawsuit, said in a statement that roughly 3% of its total net revenue is tied to a number of the 400 previously adopted fee filings that were challenged by SIFMA and Bloomberg LP, which the SEC sent back to the exchanges for further review.

While the SEC said its ruling concerned only the two fees originally named in the case, the decision has thrust the exchanges' ability to raise prices down the line into uncertainty.

Keefe Bruyette & Woods analyst Kyle Voigt said he could lower his 2020 earnings per share estimates by as much as 3.5% for Nasdaq, 3% for Cboe and 2% for ICE if the exchanges cannot elevate prices in their public or private U.S. stock market data feeds, as well as in equity and options connectivity fees, in the future.

The exchanges started to feel pressure in their stocks Oct. 17, the day after the SEC's ruling. At the market's close, ICE shares had dropped 1.83% to $73.57 on the day, Cboe shares were down 0.15% to $102.64 and Nasdaq's stock had fallen 1.59% to $80.63. The S&P 500 was nearly flat for the day.

"[Stock market data is] a big part of [exchanges'] business," Tabb said. "If they lose their appeal, they're going to wind up either having to roll back prices or refile hundreds of different pricing applications with much more stringent economic justifications."