An Exchange Goes Public

BATS is going public today.  It’s doing it on its own exchange.  Congratulations to them.  It’s hard to go public.  If you don’t know what BATS is, it’s an alternative to the NYSE and NASDAQ.  The first time it tried to go public, it had a “technical failure”.  That was pretty embarrassing for BATS since an exchange shouldn’t have a technical outage-especially when it is going to list its own stock.

From a broader perspective, I am really glad BATS is going public.  I would like to see more companies go public.  The discipline and transparency that the public markets provide are good for companies.  I also like to see everyone from anywhere with any sort of financial means get to invest in companies that they want and they can only do that with confidence when they are public.

I was an early advocate of exchanges being public entities and I still am.  You cannot imagine how incredibly bureaucratic exchanges were before going public.  I certainly can find fault with publicly listed exchanges and the way they are structured or the business decisions they make.  But, they are better off being public and it’s better off for the trading community if they are.

The exchanges had highly centralized management structures.  As a board member, I was given a lot of power to make decisions.  Members trusted me. I had to solve problems. Committees weren’t like government committees. The decisions made there were actionable, and enforced. Being a board member at an exchange was not dissimilar from being an upper level executive at a corporation.

Like a political election, I had to face the membership and campaign to get elected.  That created all kinds of political division on the floor.  If you think we are divided in America right now, you should have been on the floor during the 90’s.  Instead of just believing in a cause or thinking you are wrong and they are right, add in a heavy dose of money to the mix and you will see emotion, passion, and tempers flare.

The role of board members has changed at exchanges. They are more like corporate board members in other companies. Of course, because the business isn’t understood by many people, at our exchange we ensured that actual traders would always have input on the board.

The real problem with exchanges is that the SEC and CFTC have made it really expensive, and really hard to start up competition in the exchange space.  If the barriers to entry were lower, we would see more competition and traditional exchanges would have to fight harder to retain their business.  Creative destruction and free market competition are good for the public.  Too often, competition is regulated away.

There are some people that think BATS is part of the problem with the stock execution business.  My friends at Themis Trading have written about BATS on their blog. They see good things and bad things about the exchange.

Yesterday, Joe Ricketts wrote a short piece in the WSJ about trade execution.  I agree with a lot of it, and I would like to have a really in depth discussion about “pay for order flow.”  Personally, I think it probably creates economic incentives that shouldn’t be there.  If I could have stood on the top step and paid for order flow I’d have done it. I would be ditching out the orders I knew I couldn’t make money on and trading against the ones I could.  I don’t see how you would have had a losing day.

That’s not assuming risk and “trading”, that’s just a middleman that brokers.  I was against dual trading on the exchange floor, and I am against it in an electronic environment.

Most people have an idealized version of how their stock orders are handled.  They think they are routed to the NYSE or NASDAQ and enter a big pool where they are competitively addressed.  That used to be true but hasn’t been for a long time.

The business is still competitive.  The costs to execute have gone down for individuals. For most individuals, the slight tip in the competitive landscape doesn’t matter.  But, for others it does.

ISE is the exchange featured in the Michael Lewis book and has been profiled on 60 Minutes.   There has been a lot of public comment on ISE.  Much of it con, but a lot of it pro.  ISE is using technology to try and change the way the game is played.  It will be interesting to watch if they are successful.  If they aren’t, that’s okay.  Governments and regulators shouldn’t pick winners and losers. Customers should. Again, make it easy for exchanges to come about, and we will see a lot of competition in this space.

A hallmark of the capitalistic system is that individuals have choice. You may not like McDonalds, but you are not forced to go there. You can spend your money at a different fast food outlet. You can go to the grocery store and make your own. Or, you can even grow your own.

To give you a flavor of how competitive the exchange space is, here is a discussion between the CEO of IEX and the CEO of BATS. I look forward to them competing on execution and not with words.