• Chris

New exchanges or new platforms?

It seems that new exchanges are being established constantly. So much so that the UK regulator, the licensor of new exchanges, now charges £250,000 just to receive and opine on a new exchange application.

To me, this is a telling marker – “I need to charge you some money so as to be able to decide whether I am going to supervise you”. Urgh.

Yet new exchanges come forward.

In the last several months, I have been involved in advising two new stock exchange projects. The exciting thing about these, to me, were that they are to be set up in sovereign countries that have no stock exchange. After all you only ever start up a country’s first national stock exchange once.

However, underlying both of these projects are new IT platforms. These introduce new technology to remove the need for expensive intermediation and automate many of the traditional functions of legacy markets.

If you like the propositions are new technologies looking for markets to support.

Most existing exchanges have OK platforms that operate reasonably effectively, otherwise they would not be in business. There are dozens of IT companies who have built their own trading systems intent on selling them to exchanges.

Being in a buyer’s market, my clients reached out to non-stock exchange supported countries suggesting that they should have one if only for national pride. Old stagers, like me, get brought in to write rulebooks around the platform’s operating system, talk to the regulator and take a red pen to the business plan.

This approach has a high probability of failure.

Markets beget exchanges.

Markets are groups of ordinary business people with an interest in selling something to others; buying something from others or both things on behalf of others. Somebody produces – somebody consumes. They need a market structure under which to make this trade happen which necessarily includes a code of conduct, a method of establishing consensus prices, arrangement of trades and incentives to honour commitments made to counterparties.

These elements can be brought together under the aegis of an exchange. If the exchange is more attractive as a place to do business than alternatives, it will thrive. If not, the concept will fail.

A technology platform, by itself, can provide few of these attributes without support. There needs to be an incentive to bring business being done elsewhere, onto the platform.

In one of my projects, the business that was being done was done quite successfully in exchanges outside the country. Yes, a national exchange is all very well, but who pays for it? This can be a simple but devastatingly tough question to answer with any conviction.

Some years ago, in conspiring to launch a new stock exchange for small companies in the Midlands, the answer to this question was clear. The business was not being done elsewhere and the new exchange would enable small companies to raise capital from regional investors in a way that was actively being discouraged in London. We had the system, the budget, the issuers, investors and some intermediaries. We even had regulatory support.

So, the incumbent national exchange reported us to the EU competition commissioner for abuse of state aid – which took 18 months to sort out and exhausted the budget.

Timing is another ingredient to get right.

The other exchange project is a different example. This is a country’s attempt to win back its trade into its domestic control having historically functioned as a supply depot. Foreign traders have for years produced large volumes of tradeable commodities from this country and exported them for trading over exchanges closer to the consumer. Inserting a domestic exchange with pricing and market discipline over established practices is a difficult, but not impossible, nut to crack.

The IT system is there, and is a major proponent of an exchange being developed - obviously. But before one wheel-barrow load of any commodity can trade on the highly capable infrastructure, some big political problems have to be overcome.

This raises in my mind a thought that I cannot satisfactorily answer. 40 years ago in London exchanges supported the trade a wide variety of commodities. As purely financial “commodities” became more popular and volumes sky-rocketed, these traditional commodity exchanges disappeared.

Has the intrinsic need for these exchanges completely disappeared? Or has financial regulation, or easier profit-generating intermediation, or the removal of price risk in those commodities severally or together meant that these exchanges cannot provide an attractive means to support trade anymore.

Because there are many IT platforms looking for markets to support.

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