Are Exchanges Monopolies?

At the FIA conference in Boca Raton, Florida, some exchange CEO’s were on a panel.  The subject of monopolies was broached.  Robert Greifeld, head of the NASDAQ ($NDAQ) said, “Monopolies are great if you own one,” he said during a panel discussion at the annual Futures Industry Association conference in Boca Raton, Florida, paraphrasing a quote he recalled hearing from an investor. His exchanges don’t use this system. “We have yet to find a customer who is in favor of the vertical model.”

Interesting that Greifeld says that.  Remember, he comes from SEC regulation land.

Phupinder Gill of $CME disagrees.  Remember, he comes from CFTC regulation land.

Gill also made a comment about innovation.  I’d disagree with him on that.  Futures markets haven’t been very highly innovative.  They trade the same stuff they did since 1982.  Not much new to trade-just line extensions.  New Coke, Cherry Coke, Diet Coke.  Innovation should make customers closer to end users, and flatten out chains of distribution.  All innovation did in the futures industry was eliminate floor brokers, and create hierarchy.  That in a time when P2P is becoming a dominant theme-and hierarchy is being blown up.  No unbundling in futures markets either.

Are exchanges monopolies or not?  Just depends on your perspective and where you draw the lines.

First off, it’s extremely hard to startup any regulated exchange.  Costs are massive. Regulatory fees, lawyers fees, lobbyist fees, this fee and that fee.  It’s basically impossible.  Exchanges have more of a monopsony than monopoly.  Or, an oligopoly.   Just depends on your perspective and how you draw the lines.

I can certainly make argue both cases in the CFTC regulated futures industry.  They are almost certainly monopolies.  It’s basically one contract, one exchange when you look at volume and open interest.  No exchange is able to steal a contract from another.  Once the network effects tie a contract to an exchange, it’s game set match for eternity.  The revenue number and cost numbers become the kinds of things Private Equity firms like.

On the other hand, there are a lot of ways for folks to hedge risk depending on how sophisticated they are. They can bypass exchanges and get the same risk transfer.  Swaps, options, privately negotiated contracts and other means of hedging are used by all kinds of entities to move risk away from their operations.

Anyone can list most futures contracts.  The only ones that are beholden are branded ones, like S&P futures.  Bonds can be traded anywhere.  Hogs too.  Corn too.  Coffee too. The reality is, no one does and if they do they are unsuccessful.   The only time it’s ever been done is when the German Eurex exchange “stole” the German interest rate contracts from the LIFFE.  It proved two things.  German banks have the power to force German debt to be traded on a German exchange.  It also showed a preference for electronic trading versus open outcry trading.  I am not sure which was more powerful.

Are there monopolies among stock exchanges?

But what about Nasdaq?  Or NYSE? They are getting their ass kicked.  Why? Mostly due to really shitty regulation on behalf of the SEC which is controlled by the customers of the Nasdaq.  While futures regulations and operations have problems associated with the CFTC and exchanges, the SEC side of the business is much worse.  Front running, internalization, pay for order flow fungibility and all kinds of abuses are standard operating procedure-codified in regulation.

I’d rather see the SEC adopt a style similar to the CFTC, and let the competition begin.  But the big players on that side of the marketplace wouldn’t ever want that.  Then the Private Equity firms might not like their top line revenue variability.

Here is a different way to look at it.  I am 6’5″.  Am I tall?  Or not.  Just depends on your perspective.

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