Will Consolidation or Fragmentation Follow NYSE–ICE, Bats–Direct Edge?

Some will see these mega-deals as part of a major shakeup and others will regard them as just another phase in the Big Bang–Big Crunch cycle that exchanges periodically go through. Often, one begets the other. For instance, a purchase by the Maple Group brought Toronto's TMX Group under the same umbrella as the competing Alpha exchange, but now the proposed Aequitas Exchange threatens to divide Canadian liquidity once again. IEX launched in the US in late October. Bats and Chi-X Europe joined forces only to see Aquis Exchange, which received approval from the UK's Financial Conduct Authority this week, step in as a new pan-European venue. The new Bats–Direct Edge entity may follow through on Direct Edge's plan to invade the Brazilian market, where BM&FBovespa has dominated since the nation's two biggest exchanges combined in 2008.

"I don't view [Bats–Direct Edge] as part of a consolidation phase," says Direct Edge CEO William O'Brien. "What I've been trying to do since I got here is break that oscillating wave of fragmentation and consolidation. In the early parts of the 2000s, all the insurgent competitors were bought up by the legacy exchanges. Nasdaq bought Brut and Inet, NYSE bought Archipelago. Bringing these two companies together gives us a chance to be competitive with the legacy exchanges for decades to come. I don't think you're seeing, this time, all the old-line guys gobbling up all the new-line guys and going back to monopoly or a duopoly."

O'Brien and his Bats counterparts can plausibly argue that their partnership increases competition—an argument usually reserved for new entrants to a market—because it creates a powerhouse in the mold of Nasdaq OMX and NYSE, which will theoretically be forced to improve their offerings.

The Fallout
The NYSE–ICE and Bats–Direct Edge deals mean that the two largest equity exchanges in the US will be headquartered somewhere other than New York—ICE is Atlanta-based and Bats is in Kansas City. But that may not last long. There is widespread speculation that ICE bought NYSE just to get its hands on European derivatives exchange Liffe, and that Euronext, the NYSE trading pits, and NYSE Technologies could all be divested.

"It would not surprise me at all if ICE CEO Jeff Sprecher rids himself of NYSE Technologies," says Peter Lenardos, director of pan-European diversified financials at RBC Capital Markets. "It would surprise me more if he kept it."

Any competitive exchange will look at what its competitors are doing ... and decide whether or not to respond and how, including additional M&A. - BATS COO Chris Isaacson.

Bloomberg and Markit have been rumored to be potential buyers for various parts. A regulatory filing earlier this year revealed that, before ICE, NYSE was in talks with "a large industrial and financial holding company" that turned out to be Berkshire Hathaway. Depending on who ends up with the equity exchange, the market landscape could shift again.

Another thing to look out for is retaliatory mergers and acquisitions (M&A) by competing entities. CME, a rival of ICE and a rival bidder for NYSE, could make a move. So could Nasdaq OMX. So could Deutsche Börse, whose attempt to buy NYSE was sunk late in the game by European regulators.

"Any competitive exchange will look at what its competitors are doing, including M&A transactions, and decide whether or not to respond and how, including additional M&A," says Bats COO Chris Isaacson. "So I think it's part of the competitive landscape. But I don't think one M&A begets another."

Moscow Exchange, Borsa Istanbul, and the Japan Exchange Group, all products of recent mergers, are in the market for partners outside of their borders. So are the Australian Securities Exchange (ASX) and TMX Group. The Warsaw Stock Exchange and CEE Stock Exchange, based in Austria, are in talks with each other.

All potential deals are of course contingent on regulatory approval, which is never a slam-dunk. The Singapore Exchange thought it had a deal for ASX in 2011 until the Australian government blocked it for nationalistic reasons. Maple Group's bid for TMX received a warmer welcome than did the London Stock Exchange's, which came in with an earlier bid. Nations have an emotional and political connection to their exchanges and often feel uncomfortable ceding control to a foreign company.

Even when two exchanges are domiciled within the same borders, they cannot have excessive product overlap. When Nasdaq and ICE tried to buy NYSE in 2011, the US Justice Department made it clear that it would never allow such an equities monopoly to stand.

"Like any other industry, exchange merger approvals are really nothing more than an assessment of market concentration," says Matthew Heinz, an equity research associate at Stifel Nicolaus.