In Two Days, Signals of Change

American football season is almost upon us, and with it returns the an old adage—that 'the backup quarterback is the most popular guy in town'. He brings something different to the table. Backups are often young and promising, just want the opportunity to play, have to be ready when called upon, so on and so forth as the cliches go. Sometimes, the backup just pushes his way into the starting job with talent. Usually, a pretty steep learning curve comes with.

New York, with two football teams, has a pair of starting signalcallers; likewise for American equities, NYSE and Nasdaq have long been the two at the top. Many might see last week's twin events as the beginning of a changing of the guard, with Bats and Direct Edge pushing through with a merger, just as Nasdaq very publicly faltered—and those sentiments could prove right, or premature. But what's clearer is that Thursday and Friday's events were both long in the making, and are indicative of what's to come.

Slow, Not Sorry
That includes a couple technology trends, too. First is that in the world of electronic exchange venues, repeated mistakes and learning lessons are not mutually exclusive things anymore—they both continue to happen. 2007's Regulation NMS has been flogged over and over for the unintended chaos its best execution mandate created in U.S. equities. The new rules gave birth to a range of alternative trading systems (ATSs) and eventually, full-fledged exchanges like Bats. Many of those have grown sensibly, targeting niche clientele or products, while often also nibbling away at the larger exchange operators' profits as volumes over that same period—particularly from retail investors—has steadily gone to other venues, or different asset classes altogether.

It is difficult to say whether the Nasdaq market data glitch last week, along with the botched IPOs, and other well-publicized mishaps at the two largest exchange operators, should be blamed on that resultant competition, or rather if it is simply a natural byproduct of more IT inter-dependencies, or both. Whatever the source of the pressure, though, it isn't going away, and Nasdaq's reaction to Tape C's Securities Information Processor (SIP) irregularities on Thursday was decidedly conservative—a reaction squarely reflective of the cost in both dollars and image suffered by Knight Capital, Bats, and the exchange itself during the Facebook offering last year. 'Better slow and safe, than slow to react and sorry' isn't a bad policy, especially for an exchange. But it implies a new normal in terms of operational disruption that, to those investing or overseeing markets alike, isn't particularly palatable.

De-Demutualization
The announced Bats-Direct Edge merger, of course, was quite opposite of conservative, and it signals the second trend. Once-small, privately-owned venues are gradually becoming more aggressive, and after the wave of demutualization saw many exchange operators go public in the past two decades, the pendulum may just be swinging back. Nasdaq, itself, was approached by Carlyle Group this past February about going private before disagreements over the price broke discussions off—for now, anyway. For its part, meanwhie, Bats says the newly-formed company has no plan on going public soon after its previous, failed attempt last year. 

That the flurry of consolidation and merger activity continues unabated indicates something else about exchange technologies, too. It would appear that investors view them as broadly undervalued, perhaps owing to (often deserved) negative popular perception of recent market events. They might also be inefficiently utilized, even by the very folks that initially build them.

To that point, some wonder if—or, more likely, how—the merged venues can build a robust suite of market data products and connectivity services befitting of the second largest global exchange. If the new Bats intends on successfully entering Brazil, or challenging its older counterparts on listing services, as they hope, they'll have to.

The Bottom Line
Newly-formed companies tend to be good at that piece of the puzzle—they often merge because of a bright, previously untried idea, rather than a perfect match, and both Bats and Direct Edge have a history of rapid success in identifying, and then filling, the breach. But they have always done so under the cover of two formidable lightning rods in NYSE and Nasdaq, and are scaling bigger just as federal regulators' exasperation reaches new heights. The bright lights are only getting brighter—calls for costly circuit breakers and controls, only louder.

The great unknown, then, is not whether the new tie-up will be profitable, but whether it can ultimately reshape what it means to be technologically accountable, rather than just very—indeed, disruptively—technologically able.