Will the BATS-Direct Edge Merger Raise Stakes for Rival Exchanges?

Consolidation of exchanges is once again a hot topic as BATS Global Markets and Direct Edge Holdings reached a definitive agreement to merge their operations, a step that will create the No.2 largest US equities market by volume.

By teaming up, the two securities exchange operators will jump ahead of Nasdaq to become the second largest exchange operator in the United States. Over the past month, NYSE Euronext's exchanges represented about 22.5 percent of all stock trading over the past month, while Nasdaq’s platforms had 17.5 percent, BATS and Direct Edge together had 20.5 percent.

“From a deal standpoint, it’s certainly doubling down on US cash equities,” said David Weiss, senior analyst at Aite Group. But more importantly, according to Weiss, the merger of BATS and Direct Edge is going to put pressure on Nasdaq OMX, one of their rivals.

“Certainly in light of recent events, it puts the screws on Nasdaq pretty badly. There’s no doubt about that,” comments Weiss.

While a deal between BATS and Direct Edge was reportedly in the works for several weeks, the timing of the merger coincidentally follows last week’s malfunction at the Nasdaq OMX, which led to a three-hour market-wide shutdown in trading of Nasdaq-listed securities across other exchanges and dark pools.

The combined company will utilize proprietary BATS technology and will be headquartered in the Kansas City, Mo. area where BATS is based, with additional offices in Jersey City, N.J., New York and London. Joe Ratterman, currently chief executive officer of BATS, will remain CEO of the combined company, while Direct Edge’s CEO William O’Brien will become president. Financial terms were not disclosed for the transaction, which is expected to close in the first half of 2014, subject to regulatory approvals.

“This agreement is an important milestone for the U.S. equities market and other markets around the globe as it will combine two organizations that have been innovative in creating a more competitive marketplace to benefit all investors,” stated Ratterman.

The two companies plan to retain all four of the BATS and Direct Edge U.S. equity exchange platforms, including BATS BZX and BYX Exchanges and the Direct Edge EDGX and EDGA Exchange. Each of these platforms has different fee schedules and is aimed at different customer segments.

“Direct Edge and BATS were both founded on a commitment to create an optimal trading experience for a diverse member base, from retail investors to broker-dealers to institutions. Together, the best of both organizations will work to further improve how the world trades, consumes market data, and accesses capital markets,” said O’Brien in the release.

Despite the series of technical problems that have plagued exchanges recently, raising concerns about the stability of the stock market’s electronic trading technology, Weiss said that BATS’ technology is as good as anyone else’s. “They’re not a technology threat. I couldn’t say for sure if BATS/Edge is going to have better technology,” said Weiss.

Both companies were founded to take advantage of electronic trading and built trading platforms that cater to high-speed traders. They also run leaner organizations and don’t own their own data centers and rent space in third-party facilities. BATS operates its matching engines out of a data center operated by Savvis in Weehawken, NJ., while Direct Edge’s exchanges are colocated at Equinix's facility in Secaucus.

Merging may also help BATS and Direct Edge bolster their businesses against the declining volumes of US equities trading. BATS operates a US options exchange and also operates Chi-Ex Europe, the largest stock exchange in Europe, while Direct Edge is working on setting up an equity market in Brazil.

Ratterman told the New York Times that together they are looking at expanding into bonds and currency trading and building stock exchanges in places like Canada and Japan.

However, Weiss also points out that a combined BATS and Direct Edge are going to be surrounded by giants like ICE/NYSE Euronext, Deutsche Borse and CME, which have moved into derivatives.

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