The acquisition of London Stock Exchange Group PLC by Deutsche Bourse AG — and the expected bidding war for LSE Group that's expected to include Intercontinental Exchange Inc. and CME Group — is expected to have little impact on institutional trading, although there is the possibility of higher trading costs as fewer market operators run lit equity exchanges.
London Stock Exchange Group and Deutsche Bourse on March 16 announced they would combine in a “merger of equals,” to be based in London. Atlanta-based ICE is expected to make a counteroffer, as is CME Group, Chicago.
A potential cost increase in equity trading is probably the only negative for institutional investors from whichever firm ends up buying LSE Group.
“If more lit markets were operated by fewer parents, with fewer "parents' in the game, they may ultimately have even more pricing power over data feeds, hence higher potential costs for everyone, assuming those costs get passed on in the ecosystem,” said Ryan Larson, head of U.S. equity trading at RBC Global Asset Management (U.S.) Inc., Chicago.
Kevin McPartland, principal, market structure and technology at Greenwich Associates, Stamford, Conn., agreed that there's a possibility for higher trading costs but also said he thinks that scenario is unlikely.
“With fewer exchange operators in the world, the more pricing power each one would have,” Mr. McPartland said. “I don't think that would necessarily be the case; CME, ICE, Deutsche Bourse would all continue to operate in competition with each other. But the possibility would be there with fewer operators.”
The potential acquisition of LSE Group is not guaranteed, said Joseph Saluzzi, partner, co-founder and co-head of equity trading at Themis Trading LLC, Chatham, N.J. If an acquisition does happen, he thinks trading costs won't increase — in fact, they could conceivably go down.
“The explicit costs that exchanges charge would likely remain the same,” Mr. Saluzzi said. “The maker-taker model has pretty much standardized these rates across the exchanges. Implicit costs are also not likely to change since there would be no aggregation of liquidity.”
Mr. Saluzzi said that if the number of venues were drastically reduced, liquidity would be focused on a limited number of exchanges “and costs would come down since it would be easier to access without having to deal with the noise of high-frequency trading.”
The deal would reduce the number of equity market operators, but it would do nothing to stem the proliferation of equity market venues that has led to concerns about a fragmented stock market structure, sources said.
The issue of equity market fragmentation isn't about the number of venues, Greenwich's Mr. McPartland said. It's about the fragmentation of liquidity, which won't change no matter which exchange operator ends up with LSE Group.
“There's been consolidation (among exchange operators) for years,” Mr. McPartland said. “Now you're left with just a handful running many, many markets. It's proof that the exchange business is a profitable business if those businesses have scale.”
RBC's Mr. Larson warned that any deal for LSE wouldn't signal a reduction in the number of trading venues because past venue operator mergers, such as the 2014 acquisition of Direct Edge by BATS Global Markets Inc., haven't cut the number of equity markets.
Mr. Larson warned not to assume that “just because LSE is up for sale it means the trend among lit markets is to consolidate. BATS/DirectEdge was a classic example of why that is not the case, as they left all four legacy exchanges to operate. As exchanges are owned and operated by for-profit entities, at least domestically speaking, I fear that decisions far too often are made along the lines of what is in the best interest of the unitholder, for example, the shareholder, as opposed to what is in the best interest of fair, transparent, liquid and competitive markets.”
Added Mr. Saluzzi: “In the U.S., I doubt you will see any mergers of the big three (ICE, Nasdaq and BATS) due to antitrust concerns. And even if the exchanges did manage to get approval to merge, this still wouldn't help fragmentation since they likely wouldn't shut down any of their exchanges. ... Exchange business models thrive on fragmentation — the more of them you own, the more data feeds, co-location space, ports, etc., that you can sell.” n
