CurveGlobal’s current Jump Ball initiative is the latest in a growing trend towards the remutualisation of market infrastructure, but it will take more before the concept becomes reality.
Back in the day, members owned exchanges. The seats around the pits constituted their share in the business which rose or fell in value based on supply and demand, and fees were set to break even or return small profits to members.
Exchanges were predominantly local institutions trading local products for a local market so had little need for large infusions of cash to expand into new markets, new verticals or to acquire their rivals.
All that changed with the advent of electronic trading. No longer did exchanges need to be physical places limiting access to a select group of high payers. Anyone, anywhere in the world could potentially trade the market and this redefined the potential of exchanges, creating an entity unsuited to the staid old world of mutual ownership.
Moves towards demutualisation were already underway before electronic trading started to revolutionise markets, with the first exchange demutualisation in Sweden in 1993. But electronification accelerated the trend and by the turn of the century most major non-US derivatives markets were no longer member owned.
The US exchanges were slow to the party owing in part to their longer standing under member ownership but by 2010 almost all major international derivatives markets were demutualised with the subsequent Initial Public Offerings (IPOs) flushing them with cash to go on spending sprees across the globe buying other markets and consolidating market infrastructure.
Mutualised exchanges were not just good for the members. New contract launches, now one of the biggest challenges faced by exchanges, were made easier by the ability of exchange management to cajole pit traders to trade (Leo Melamed and Jack Sandner’s legendary request of “15-minutes please” to traders to get the S&P futures launch being the most obvious example).
But the traders also realised that a successful new contract launch would boost the overall value of their memberships so were aligned with management in making that contract a success (However, as Michael Gorman notes in his excellent book From Pits to Bits, this alignment declined as seats were increasingly rented by retired owners).
There were of course draw-backs. Member-owned exchanges were bureaucratic and slow to make decisions owing to the need to protect the broad spread of member interests. The cost to the ultimate end-user of these closed entities was also a factor, although one that was never fully quantified.
Costs have dropped and volumes have soared dramatically since demutualisation, although the evidence of the London Metal Exchange, the last of the recent major exchanges to demutualise, suggests electronic trading and the globalisation of markets more generally played a key factor in these trends as well.
But, following the wave of mega-mergers between exchanges since the turn of the century (more often local consolidations over cross border acquisitions), market infrastructure has flipped from member-owned monopolies to shareholder-owned monopolies. This transition is crucial for the market as it represents a shift of interests away from the market and towards the shareholders.
Sentiment against these monopolies is growing across the market. Rising market data fees in particular have caused consternation, with growing anger in a number of markets. Ultimately all monopolies no matter how large have limits to their ability to squeeze a market.
It should not be surprising therefore that partnerships and shared profits are increasingly on the agenda, not just at newly launched exchanges, but also as a strategy for incumbents seeking to launch new products.
This week CurveGlobal announced an equity sharing model that represents a step towards some degree of mutualisation, albeit very limited at this stage.
This is not a new trend in derivatives markets. NYSE Liffe US sold a significant stake in its derivatives platform to its members in 2009 and TOM (The Order Machine) in Amsterdam was wholly owned by a handful of market participants. CME Europe innovated two years ago when it effectively sold shadow equity in its cocoa contract by allowing market participants to invest £50,000 upfront in return for a profit share.
Of course, one key theme that unites NYSE Liffe US, TOM and CME Europe is that they are no longer in business having been absorbed into ICE, shut down after a failed sale process and just shut down.
But that doesn’t mean that attempts at partnership are dead or that the market is not warming to mutualisation.
SwapClear is the shining example of a mutualised model in the market and it continues to dominate in the exclusively bank-run world of over-the-counter clearing. Eurex Clearing is seeking to offer a partnership model for clearing to take market share away from SwapClear and LME launched its precious business offering a very complex but to some extent mutualised model.
NYSE Liffe US, TOM and CME Europe bear witness to the failure of part-mutualisation as a concept. All three had limited shareholdings rather than broad shareholdings across the market. NYSE Liffe US sold equity to a few banks and CME Europe attracted only a few buyers for its innovative contract launch structure.
TOM perhaps came the closest to success but ultimately just fragmented between its shareholders, trading the retail flow delivered by Binckbank, which had a stake in the company and the flow generated by the increasingly powerful retail broker De Giro, which was firmly in the camp of TOM’s arch-rival Euronext. Unable to bring De Giro on board, TOM ultimately failed.
For remutualisation to work in today’s market the base of participants needs to be broader than that attempted by NYSE Liffe US, TOM and CME Europe. It needs perhaps to be broader than the original categories of membership in the pre-demutual world of exchanges.
Bringing together such a wide and disparate group of participants is next to impossible today but the growth of distributed ledger technology suggests that it may become easier. DLT lends itself naturally to mutualisation. Each node in the chain could become the effective equivalent of a seat on the old exchanges.
Currently efforts surrounding the DLT are mainly attempts to build faster horses. It is impossible to envisage the changes that the technology will currently bring as they do not exist as concepts today. But one significant change could be a return to mutualisation of market infrastructure. The will is clearly there and the technology is emerging, if current trends continue, remutualisation will be hard to stop. CurveGlobal may be on to something.