Exchanges, under profit pressure, mounting defense

Rise of the upstarts

A series of rule changes since the late 1990s, first in the United States and then in Europe, opened the door for privately owned alternative venues to take on the exchanges -- which responded with a flurry of acquisitions that left few standalone national markets.

Now, some 35% of U.S. equities are matched outside of exchanges, whether they're over-the-counter, on venues such as Direct Edge, or in dark pools, the anonymous venues that account for up to 15% of the market.

In Europe, a few years behind changes in the United States, dark pools represented only 1.2% of trading, according to Thomson Reuters. The value of those trades jumped fourfold from January to 9.5 billion euros in October.

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Competitive pressure will only increase.

As a result "we've seen this downward spiral on pricing. These smaller guys can be very aggressive on pricing, and it's mainly due to the fact they've got this low overhead compared to the exchanges," said Sang Lee, managing partner specializing in market structure at Boston consultancy Aite Group.

"If anything, the smaller players have dictated a lot of the pricing changes we've seen over the last couple years."

Robert Greifeld, Nasdaq OMX's chief executive, said that while many of the company's pricing adjustments worked this year, in "others we were essentially giving away money that wasn't having any impact on customer behaviour."

The London Stock Exchange, New York's NYSE Euronext, and Toronto's TMX Group Inc have scrambled to adjust both the fees charged and the rebates provided as market share slipped in the last several quarters.

New regulation is the wild card.

Regulators on both sides of the Atlantic are probing dark pools and other developments in the complicated and interconnected marketplace. The U.S. Securities and Exchange Commission last month proposed rules that would bring more transparency to dark pools.

"Whatever change that we may see in the U.S. market, we could certainly expect to see something similar happen in the European market," Lee said.

"As off-exchange market share increases, the (European) regulators will have no other option than to look to the US because the overall market models are so similar."