Where have all the exchange platform providers gone?

To paraphrase the comic Eddie Izzard:  “Building an exchange, are we? That’s a fantastic idea! Marvelous religion those exchange people have got. Yes, a lot of colorful jackets, I like that…” First fun fact: Izzard attended the same school as me, but some years earlier, I should note, and was much better at French, according to my teacher.

Anyway, exchanges are a critical part of the capital markets infrastructure. They’re the facilitators of buying and selling securities and derivatives; the meeting place for buyers and sellers. But what were once bustling trading floors filled with loudly yelling traders with colored jackets denoting their affiliated firm are now almost entirely electronic marketplaces where orders are submitted and matched by an algorithm rather than a human being. Second fun fact: trading firms loved to hire college sports players to work on exchange floors because their height, physical presence, and sheer volume gave them the advantage of being seen and heard over their shorter, quieter counterparts

That means being a provider of the technology that supports these electronic marketplaces is a very, very good business to be in. So why aren’t more companies doing it? To use one of my favorite analogies, in Formula One racing (non-F1 fans, bear with me; this will be brief), engine manufacturers that enter their own teams in the sport—such as Mercedes and Ferrari—must also offer to supply rival teams with engines. There are advantages to this: equality across the sport, but also additional income that those manufacturers can use to bolster their own research and development efforts, and valuable feedback from the other teams using your engines. Think of each additional customer as doubling your testing capacity.

Back to the capital markets: Over the years, Nasdaq has ended up controlling the lion’s share of commercially available exchange technology platforms via its acquisitions of OMX in 2007 (which also brought it the assets of Computershare’s markets technology business, which OMX bought in 2005) and Cinnober in 2018. Its exchange technology platforms, including matching engines, risk and surveillance controls, and data distribution mechanisms, are used not only by the exchange group’s 18 markets across North America, Europe, and the Baltic states, but also by more than 130 markets worldwide, from Chile to Indonesia.

London Stock Exchange Group’s Millennium Exchange platform, originally Sri Lanka-based technology vendor MillenniumIT, which LSEG acquired in 2009, currently powers all of the UK-based exchange group’s marketplaces, as well as the Johannesburg Stock Exchange, Argentina’s BYMA exchange, and the Bolsa Valores de Lima in Peru. At the time of the acquisition, Icap and the London Metal Exchange also used Millennium’s systems, and former clients included the American Stock Exchange and the Boston Stock Exchange (now owned by NYSE and Nasdaq, respectively, and running on their parents’ tech platforms).

In the derivatives space, CME Group uses its Globex platform to operate its own markets, and also provides the platform to other exchanges, such as the Korea Exchange, Dubai Mercantile Exchange, and Bursa Malaysia.

Many of those who choose to buy versus build are second- or third-tier exchanges, mostly serving domestic and regional market participants, with some notable exceptions, such as Korea, which for many years was home to the most-traded derivatives contract by volume. Third fun fact: The exchange that currently holds that distinction, the National Stock Exchange of India, chose to build its own platform, the National Exchange for Automated Trading, or NEAT+, and proudly touts its technology investments as a competitive differentiator.

Fourth and final fun fact: the decision of whether to buy or build can be nuanced. In some cases, exchanges make a “big bank” cutover from old open-outcry floors. Sometimes they take a voice-electronic hybrid approach, and other times they go fully electronic. They may be approaching it as a greenfield implementation, or replacing a previous system that may have been purchased from a different vendor or built in-house. There’s also the motivation behind it: Is the exchange looking for a platform that can handle more trading activity, or is it looking for lower latencies or more features built into the infrastructure?

For example, remember BATS? The upstart ATS (its name was an acronym for Better Alternative Trading System) was founded in 2005 and bought the Direct Edge exchange, multilateral trading facility Chi-X Europe, and currency trading platform Hotspot before being snapped up by Cboe in 2017.

Buying a technology platform was never a consideration for BATS founder Dave Cummings, who created the ATS based on technology—“strong proprietary technology,” recalls one former BATS insider—already in use by his Kansas City, Missouri-based high-frequency trading firm Tradebot Systems. BATS’ technology was renowned for punching above its weight, giving it a technical advantage, thanks to a strong engineering presence among its senior leadership, including Joe Ratterman, who would succeed Cummings as CEO, and CIO Chris Isaacson, who now serves as COO at Cboe.

Designing, building, and running technology in-house allows an exchange to design it specifically to support its business plans beyond just operating a marketplace. Building those elements yourself doesn’t only protect against supplier risk (for example, if you start treading on your supplier’s crown jewels, or if an element of your supply chain exposes some unforeseen risk); it also gives you much more control over your future. Think being Etsy versus being a seller on Etsy’s marketplace.

“Using our own technology allowed us to have greater control over the company’s success. The team was that confident in their technological approach,” the former BATS insider says.

I would struggle to assemble a list of 10 companies currently competing in the securities and derivatives exchange technology space

But despite the few that build their own systems, the market for off-the-shelf exchange platforms has become increasingly concentrated in the hands of a few key players. The upside of this is that these smaller exchanges get access to technologies and tools that are in use and battle-tested at some of the largest global exchanges. And generally, they don’t need to worry about any conflict of interest with the provider exchange because they generally don’t target one another’s markets. The downside is that fewer providers means less competition, and generally speaking, competition = good, and monopolies (or duopolies) = bad. Also, there’s an element of technology risk associated with greater concentration. Imagine a CrowdStrike-type outage impacting any one of these exchange providers: not just their markets would be out of action; so too would all the other marketplaces they support.

Now, compare this to the burgeoning cryptocurrency space. Not only is there a plethora of “exchanges” to trade Bitcoin, Ethereum, Dogecoin, and Unobtanium (I’m kidding about that last one... at least, I thought I was. Turns out it’s an actual thing beyond the Avatar movies); there are many, many technology firms specifically offering the technology to set up your very own crypto exchange-in-a-box. There are so many that I’ve found rankings of the top 10 and even top 20 providers of crypto exchange platforms.

The traditional exchange platform operators now also support various digital assets, and even crypto companies and exchanges still have use of them. For example, in recent weeks, TS Imagine announced that CoinShares will use its TS One solution to provide trading and risk management functions for CoinShares’ new Relative Value equities hedge fund, while Dutch crypto exchange Bitvavo will roll out Nasdaq’s Market Surveillance technology, allowing the exchange to better detect market abuse, replay a consolidated audit trail of its order book, and receive alerts about suspicious activity. Why? Perhaps these simply are the class of the field in trading and risk solutions. Maybe they’re a nod to regulators’ comfort levels. Or perhaps it’s a case of “horses for courses” as these marketplaces meld digital assets and “TradFi.”

I would struggle to assemble a list of 10 companies currently competing in the securities and derivatives exchange technology space. But one that crossed my radar recently is a name I’ve known for years, though for different reasons: Connamara Systems has been around for more than two decades, providing feed handlers and other high-performance technologies for the trading community. But two years ago, the company launched a spinoff, Connamara Technologies, which exclusively provides its EP3 product, a full-service exchange technology stack in a box.

“During those 25 years, we started getting repeat customers for exchange technologies, such as matching engines. So rather than building a new exchange platform every time, around five or six years ago we built a repeatable product,” says Connamara CEO Jim Downs.

The year that Connamara launched EP3 was the same year that David Downey—former CEO of single-stock options exchange OneChicago, and with whom Downs had spent his early years alongside trading on the Cboe floor—approached the vendor about his latest venture: ForecastEx, an Interactive Brokers-owned exchange for trading on the outcome of economic and climate events.

The exchange, which went live on August 1, uses the cloud-based EP3 platform to perform market access, data distribution, order matching and execution, risk management, market surveillance, regulatory reporting, exchange operations and administration, and clearing and settlement functions—a new capability developed by Connamara specifically for ForecastEx. Its trading interface is the ForecastTrader front-end developed by Interactive Brokers.

“The way they clear instruments is a little unique. And we built that clearing component into EP3 to handle their needs,” says Downs, adding that Downey and his team’s understanding of clearing was instrumental in helping to develop its collateralized clearing capability, turning a “monumental” task into something “fairly simple.”

“We had to make some changes to incorporate these new contract types, but they were minimal,” Downs says, adding that the vendor designed EP3 to be flexible enough to support innovative new contract types—for example, the platform already runs exchanges that trade bankruptcy claims, intellectual property rights, and cash lumber markets—with APIs so that clients can connect their “special sauce” or plug it into a larger infrastructure.

“Whether I’m trading jellybeans or interest rate swaps, at the end of the day, I’m matching a buyer and a seller using an algorithm. The challenge is how you define each jellybean as an individual, tradable instrument,” Downs says. “At the core of EP3, we match instruments and define what an instrument is that makes it unique.”

This flexibility, component-based design, and ability to achieve faster time to market at a fraction of the cost of building a compliant exchange platform from scratch—shifting a large capital expenditure item into a lower, recurring operational expense—are among the reasons new marketplaces are choosing to launch on EP3, officials say.

“The hardest thing for a customer starting a new exchange is getting liquidity onto their platform. So, if we can reduce the cost of setting up, they can spend more time marketing their product,” Downs says.

Personally, I would not be at all surprised to see more cross-pollination between traditional exchanges and crypto tech startups. They each have a lot to learn from each other, especially when providing pivotal components of regulated markets. For example, Downs describes how the vendor’s system had to be demonstrably up and running with ForecastEx before the Commodity Futures Trading Commission would grant the exchange approval to operate as an exchange.

So, if you’re building a new exchange and facing these buy-versus-build decisions, or if you’re a company I haven’t heard of that’s providing exchange technology platforms, please reach out to me at max.bowie@infopro-digital.com. I’d love to hear your story.