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Exchanges Gamble On Multi-Asset Trading

For-profit exchanges are expanding into multi-asset trading to make money for their shareholders. But can they pull it off with multiple matching engines?

From the Jan-Feb 2006 issue of Advanced Trading

As exchanges transform their business models into for-profit enterprises and look to demonstrate to shareholders that they are growing their bottom lines, many are scouting for new asset classes to add to their electronic trading platforms. Offering executions in a variety of cash and derivatives instruments is a way for exchanges to beef up their trading volumes and increase their transaction fees. "When you are a for-profit entity, you look at the NYSE or the CME or CBOT, and you need to show shareholder growth and earnings - you have to move into other product lines," explains Dave Herron, CEO of the Chicago Stock Exchange (CHX).

Further, exchanges must please a new generation of hedge funds and algorithmic traders executing complex strategies that cut across different asset classes. Today, hedge funds are creating these strategies on their front-end trading systems and then executing each trade on multiple exchanges. However, there may be an opportunity to offer combination trades that execute multiple financial instruments in a single transaction.

Exchanges that have built electronic trading infrastructures would like to provide access to multiple instruments on a single platform. Since they've already made the investment in technology, those with the strongest platforms will try to expand into multiple asset classes.

New rules in U.S. equity trading also are causing some options exchanges to consider trading equities, the underlying securities for many of their options. Under Reg NMS, an exchange can attract order flow in equities if participants post the best prices on that exchange. This may lead options exchanges to start their own facilities for executing stock trades because the rules will enable them to compete against established equity markets.

Because exchanges are considering the potential for trading a variety of asset classes - including stocks, options, futures and foreign exchange - on a single electronic platform, the trend is expected to lead to consolidation among U.S. exchanges as the strongest players acquire their way into each asset class. To transform itself into a more automated marketplace, for example, the New York Stock Exchange (NYSE) - dominant in trading listed stocks - is acquiring Archipelago Exchange, an electronic marketplace. Archipelago started as an over-the-counter ECN and now is trading listed stocks, ETFs and options, with plans to add corporate bonds and futures to its platform.

Meanwhile, the International Securities Exchange (ISE), an electronic options exchange, is considering a move into equities. There also is speculation that the Chicago Mercantile Exchange (CME), a multiproduct futures exchange, is going to make a deal, perhaps acquiring the New York Mercantile Exchange, to expand into energy. And regional exchanges have jumped on the multi-asset bandwagon, too. The Philadelphia Stock Exchange (PHLX), which always traded equities and options, for example now owns a futures exchange.

Putnam's Plan

Archipelago has been the most aggressive in building a multiproduct, single platform exchange. "Once you have your core technology in place, diversifying the business and increasing the number of transactions comes naturally," says Jerry Putnam, CEO of the Chicago-based electronic marketplace. Because the technology platform is scalable, Putnam says, "You just drive the bottom line of the business by putting more transactions through it, and obviously one way to do it is to diversify asset classes."

Since Archipelago already trades stocks (both listed and over-the-counter) as well as bulletin board stocks and ETFs on the same technology, Putnam envisions adding more asset classes to its platform. "We've always viewed our business as a trade factory, and we've got the right engine to do the trades," he says, adding that it's cheaper for Archipelago to create new components and, therefore, easier to add more products than it is for a trading floor. "We have an open technology and the ability to modify it to make new products - that certainly is going to be one of our advantages," says Putnam.

Even before conversations about merging with the NYSE began, Archipelago decided to enter the options frey by acquiring the Pacific Exchange (PCX) last year. Recently, Archipelago announced that it's scrapping the PCX-Plus options platform it acquired from the Pacific Exchange and instead is building a new options platform in-house based on the same architecture that Archipelago has in place for trading everything else, according to Putnam. "The scalability of the system really pushes us to want to put [options] on the same technology that we operate for the other businesses," he says.

Additionally, in November, Archipelago announced plans to trade listed corporate bonds. Though the NYSE has participated in the business since the 1970s with its Automated Bond System (ABS), its corporate bond platform needs a technology upgrade, Putnam asserts. "In the past, they had a pretty significant bond business," says Putnam, but that has declined because, "They needed a technology upgrade, and we have the platform to do it." One major advantage is that the NYSE has huge distribution hooks into all the market data vendors. "It takes time to get all of that in place, and they have it in place," says Putnam, who notes the new corporate bond platform currently is in development and is close to going into production.

Ivy is Editor-at-Large for Advanced Trading and Wall Street & Technology. Ivy is responsible for writing in-depth feature articles, daily blogs and news articles with a focus on automated trading in the capital markets. As an industry expert, Ivy has reported on a myriad ... View Full Bio

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