MEASURES OF SUCCESS
The differences between types of venues, exchanges, electronic trading venues (Multi-Lateral Trading Facilities/MTFs, Automated Trading Systems/ATSs), and inter-dealer brokers (IDBs) has not only been diminishing in many instances they have ceased to exist. What they have always had in common is the facility to enable investors to trade with each other.
While previously comparisons were awkward, they are now relevant as regulators increasingly shoehorn them into ever more rigid categories.
Where there are important points of difference lies in the method of trading, electronic, voice, and hybrid of both. These differences seem to have a material effect on how the investing market views not only how they route their trades but also when measuring the venues themselves by value.
The 3 measures of success we analyse here, are straight revenues, the value investors place on the business, i.e. market capitalisation, and the correlation between the two, the Price/Sales Ratio. This reveals intriguing dynamics. Profitability, the most obvious yardstick has not been included as there are too many opportunities for manipulation within a short timeframe.
And the medals go to…………………………..
TECHNOLOGY DRIVING EFFICIENCY
The large exchanges are becoming hybrids by adopting strategies of first focusing on their core listed instrument business and then acquiring MTFs trading OTC markets electronically (CME/NEX, DBAG/360T, Euronext/FastmatchFX, LSE/MTS, NASDAQ/eSpeed). In the US$500 Million PA revenue space the exchanges predominate by numbers in this report with 13 entrants compared to 4 IDBs, and 3 MTFs
• The exchanges have the highest average revenues (US$2,435 Million) and market capitalisation (US$22,634 Million)
• The IDBs have comparable revenues to all but the largest exchanges but nowhere near the same level of market cap
• The eMTFs have relatively small revenues but their market cap/revenue (Price-Sales) ratio is superior to both the exchanges and the IDBs.
The eMTFs in comparison to traditional venues are technology intensive, lean staffed, high volume, but low margin, businesses, they rely on liquidity to generate levels of value. The high volumes of observable transaction data then produced enables more accurate models to be developed, analysed then used to drive more trading back to their venues. Naturally licences to use data drives additional revenue to the MTFs
VENUES RANKED BY REVENUE & MARKET CAP
The table below highlights the dominance of exchanges in terms of revenue and market capitalisation, and the ability of leading venues to build out their information services. The leading exchanges all have evolved from licencing raw data only to offering value added analytics and index business, even becoming full scale vertically integrated data aggregators. This is a transition the smaller exchanges and IDBs have yet to make
THE REVENUE/MARKET CAPITALISATION RELATIONSHIP
As noted earlier in this report, profitability is not an included benchmark, however, the relationship between market capitalisation relative to revenue generated is. This is the Price/Sales ratio, i.e. market capitalisation at current levels, divided by the latest year’s revenue.
The intention is to identify the venues which investors believe have the highest potential relative to their income, and assess why.
Potential reasons include
- High P/S rations indicate large, liquid markets open to competition with a broad client base, and structured around a core set of tradable products. There is diversity in asset classes, but they are complementary in trading terms, or for the economy they serve
- Technology that facilitates trading by investors on a global basis
- Data services that generate the price discovery for liquidity required and is friendly towards automated trading
- Data and liquidity are directly correlated
The markets in terms of trading and investment have a definite preference for venues which offer, and oriented towards electronic trading with the ability to create information services from these operations, i.e. the exchanges and fully electronic MTFs (ATS). There is also a definite preference for venues with strong balance sheets with equally strong credit ratings, two areas where the IBDs struggle.
The key comparison is the low market cap of the people intensive IDBs and the high market cap technology based MTFs which rely on systems rather than personnel.
Data: THe Sum of Human Behaviour
The data which is used by quants and others to create their models and analytics represents the sum of human behaviour in highly liquid markets. These analyses are dependent upon data critical mass, the more data, the greater the potential accuracy of the models, which in turns increases the potency of models developed using predictive analytics (AI). This favours large exchanges and very liquid MTFs.
Given this is how many institutions invest, with the number of passive funds by both value and volume now outweighing the size of their active counterparts, it is not surprising these investors view the value of the trading venues in a similar light.
It can be literally summarised as ‘Go with the Flow’, only the flow looks more like a closed loop. A trading event creates data that gets fed into a model which when analysed creates another trading event, ad infinitum. But is it?
Black Swans, Data Models & Intuition
Quants, their models and analytics can be blindsided by none other than what happens out in the real world of humans, the unanticipated interjections of man and nature (COVID-19 anyone?)
There is a definite, if currently undervalued place, for non-electronic markets and inputs, such as markets prone to arbitrary and artificial limitations place upon them, by local governments and regulators, illiquid markets where either demand or supply, sometimes both, are constrained, and where good old fashioned Indicators of Interest (IoIs) are required to stimulate trading. These are markets that need people to think. This inverts the electronic markets paradigm to one of high margin trading with a lower supply of data, but that data comes at a premium.
Placing the Premium
However for now and the foreseeable future, the markets will continue to place their premiums on large exchanges, electronic market places, especially the leaner, meaner ones, and venues able to leverage their digital assets most effectively.
Keiren Harris 12/05/2020
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