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Asset Management

09:21 PM
Dushyant Shahrawat, Research Area Director, TowerGroup
Dushyant Shahrawat, Research Area Director, TowerGroup
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Will Exchanges Represent the Next IT Gravy Train?

Demutualization is the biggest trend currently sweeping the global exchange market. Currently, there are 24 public exchanges in the world with a market capitalization of $140 billion.

Changes in the Global Exchange Market

Demutualization is the biggest trend currently sweeping the global exchange market. Currently, there are 24 public exchanges in the world with a market capitalization of $140 billion. While demutualization is taking place much faster in the U.S. than in Europe and Asia, it becomes an overwhelming issue for the global exchange sector as U.S. exchanges comprise 55% of global trading volume. Demutualization is forcing exchanges to transform themselves from staid, conservative member-owned organizations to aggressive, highly competitive entities focused on growing revenue and vanquishing competition. Question is: what's the impact of all this change on technology in the exchange market?

Several factors are driving IT strategy in the exchange sector. Going public is the biggest change driving U.S. and European exchange technology as CEO's and CIO's are now driven by analyst expectations, competitive pressures and sales targets instead of member agendas. This drives exchanges towards revenue opportunities (new data products) and offering low latency trading solutions (co-location) to brokerage firms and hedge funds.

The second factor is changing market structure. In 2007 two major market structure changes hit the global securities market: Reg NMS in the U.S. and MiFID in Europe. Together they will have a wide impact on trade volumes, liquidity and market structure in the securities market. Exchanges will need to respond by developing new exchange and clearing links, upgrading infrastructure and expanding capacity.

The next trend impacting exchange IT is greater automation and electronic trading. While exchanges have significantly automated trading and migrated from floor or pit-trading to electronic trading, this trend will continue over the next 2-3 years. European exchanges are ahead of their U.S. counterparts in automation rates while Asian exchanges lag both the U.S. and Europe. Greater automation will be a major driver of exchange IT spending in forthcoming years.

The final factor impacting IT will be new pressure on technology expenses. Public exchanges are under pressure to reduce expenses and bring them in line with other securities firms, clearing corporations and utilities. The IT expenditure of US/European brokers is 18-20% of their revenue compared to 10-12% for large sell-side firms and even lower for the average S&P 500 company. Bringing the exchange IT cost/revenue proportion in line with that of securities firms would require reducing exchange IT budgets by $800 million while keeping revenue constant.

Taking a Look at Exchange IT Spending

Looking at the dramatic change in the exchange sector, one may think IT spending among exchanges would be booming with new projects focused on driving revenue, competing better and the integration costs related to M&A activity. Our research actually indicates IT spending in the exchange market is actually growing more slowly than one would expect/ Total IT spending for exchanges around the world in 2006 is estimated at $2.7 billion and will grow at a CAGR of 2.8% for the next few years through 2009.

Truth is that exchanges have already spent enormous amounts on updating capacity, reducing latency and similar initiatives in the last few years. Spending is also being driven down by demutualization which will force CIO's to cut expenses and meet analyst expectations for cost efficiency. Finally, the M&A activity in the exchange sector is also forcing pressure on IT budgets. About 60% of all M&A activity over last few years has been motivated by cost reductions with the rest driven by attempts to gain market share and expand into new product lines or geographies.

So despite all the change in the exchange sector, it will not be a honey pot for vendors and consultants looking for revenue opportunities. On the contrary, spending will decline in the US exchange market over next 3 years and rise moderately in Europe. Asia will be the exception with Asian exchanges expected to expand their IT budgets considerably.

This article is based on TowerGroup research by Mr. Dushyant Shahrawat, Research Area Director at TowerGroup, a leading advisory research and consulting firm focused on the global financial services industry. He can be reached at [email protected].

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