Trading pits have given way to electronic trading engines in many jurisdictions. Central counterparties can no longer operate without sophisticated IT-based risk management systems. Technology has allowed exchanges to offer different types of instruments - equities, bonds, futures and options - on a single platform. It has enabled improvements in risk management processes, and open access by participants and alliance partners. BIS Review 22/2004  1  The cost of investments in technology, however, is high and can only be justified if it is supported by a large volume of trades. Shareholders will also demand that these exchanges earn competitive returns on their investments in technology. Small exchanges will thus, find it difficult to make the necessary investments to compete. This has been a key driver behind the formation of mega-exchanges, and will continue to fuel their drive for expansion. Another key driver is the need for economies of scale. Exchanges and clearing houses thrive on liquidity and scale. The likelihood of a cost efficient execution of a trader’s order is higher the larger the pool of traders on the same platform. Similarly, in the case of clearing houses, the benefits of netting and the efficiency of collateral management are greater the larger the number of counterparties using the facility. The pressure to seek economies of scale and competitive returns is accentuated for demutualised exchanges. Implications for regional exchanges Exchanges in this region are unlikely to be insulated from competitive pressures for long.

The wave of consolidation has, however, created mega-exchanges in the U.S. and Europe, and competition among them has proceeded at a furious pace. The Chicago Board of Trade (CBOT) faces a serious challenge on its home turf from Eurex, the all-electronic exchange owned by Deutsche Börse and the Swiss Stock Exchange. Eurex is now offering electronic trading in U.S. dollar denominated fixed income futures which have been the mainstay of the CBOT. The pan-European exchange, Euronext.Liffe, is offering electronic trading in Eurodollar futures contracts in direct competition with the Chicago Mercantile Exchange (CME). CME has responded quickly, announcing initiatives to accelerate the migration of its flagship Eurodollar contract to GLOBEX, its electronic trading platform. And just this month, it was reported that the New York Stock Exchange may enter the derivatives market too. Hardly a week passes without press reports of strategic moves by the exchanges. Securities exchanges have not been spared from the competition. London Stock Exchange (LSE) will launch its Dutch Trading Service, euroSETS, in May this year. This will allow the most liquid stocks listed on Euronext-Amsterdam to be traded through LSE. This bold move is being watched closely by the industry, and may challenge conventional wisdom on the contestability of stock exchange liquidity. The outcome of these contests could significantly alter the competitive landscape for exchanges in the next few years. Key drivers of consolidation and competition One key driver behind the consolidation and competition is technology. Exchanges and clearing houses are very much technology businesses today.