Over the past few decades, financial exchanges have become powerful global actors in their own right. In this post, Johannes Petry explores the politics and power of exchanges. Drawing on his recent research, he shows how they control networks along the investment chain and create the infrastructure of global finance, setting the ‘rules of the game’ for companies, investors and states.
One thing that is often overlooked in discussions about the politics of finance is the power of exchanges: the platforms upon which the financial sector’s billions of daily trades are executed. While they are often thought of as simple ‘marketplaces’, they are in fact sites of significant social power. Moreover, what they do, how, and for whom has fundamentally transformed in the last 25 years.
As I explored in a recent New Political Economy article, exchanges have become powerful actors in their own right that organise and control the very stuff of financial markets: data, indices, financial products, trading platforms, clearing and all. In doing so they set the rules by which market transactions take place. Put simply, exchanges create the infrastructure of global finance.
What do financial infrastructures do?
It is easy to imagine financial trading takes place simply because buyers and sellers of financial products find matching needs. Yet before such needs can even be discovered, there must be mechanisms in place for ‘payments to be settled, risks assessed, and prices agreed’. While often taken for granted, infrastructures are the social, cultural, and technical conditions that make markets possible and this has political significance.
Investigating infrastructures in financial markets ‘sheds light on the different ways in which authority is formed and exercised in global finance’. While recent research has hereby focused on the relational aspects of infrastructural power and the entanglement of states and finance (see for instance the excellent work by Braun, Gabor or Bernards & Campbell-Verduyn), power can also derive from control over key financial infrastructures. This is key to understanding why exchanges matter.
Exchanges are powerful because of their role in organising the infrastructural arrangements of financial markets. By organising financial infrastructures, exchanges can ‘rewrite the rules of the game’, and thereby constrain and influence the actions of those actors who rely on them – including (listed) companies, investors and states. Hence, the power of exchanges closely resembles what Susan Strange defined as structural power – the ability of powerful actors ‘to change the range of choices open to others without apparently putting pressure directly on them’.
How exchanges control the investment chain
Take the London Stock Exchange (LSE) Group as an example. While previously merely a marketplace to trade shares of UK-listed firms, LSE Group has become a global financial powerhouse.
With Millennium, they own a market technology which they sold to over 40 marketplaces around the world, shaping how these markets work. In their own markets, they control the distribution and access to market data, which is crucial for making investment decisions, whereby they have ‘monopoly pricing power’ over financial knowledge. LSE also bought FTSE Russell, a leading index provider which steers capital in and out of countries and companies based on its index in- and exclusions. A recent Forbes article dubbed these decisions as more important than the activities of the likes of Goldman Sachs, Black Rock or Moody’s. Next to the London stock market, LSE also own the Borsa Italiana and operate several European trading platforms for stocks, bonds, ETFs or derivatives. By organising these trading venues, they actively encourage the listing of financial products essentially creating and defining what investment opportunities are. They also decide the rules of how trading is conducted which has an impact on the type of trading that takes place on their markets, as evidenced by exchanges’ role in facilitating high-frequency trading. LSE also owns LCH Clearnet, the world’s largest clearing house whose collateral rules influence investment decisions, whereby they basically decide which assets they deem safe enough to back transactions. This, for instance, impacted countries’ refinancing operations during the Eurozone crisis.
Importantly, this power is entrenched through synergy effects emerging from their combined ownership of all these infrastructures along the investment chain. As the APAC Director of a global exchanges noted:
Because we own so much more of the value chain, […] we have revenues stream out of every aspect of that. […] You really want something that has synergistic … complementarity […] Next to the stock market, we have the no.1 platform for launching and trading ETFs. Then we have the futures business, which is used for hedging those ETFs, and then off course, I mentioned all the data that flows alongside in that silo. […] That’s basically how we try to shape the business, as an entire value chain where clients want to see that all on a single platform where they can have a single trading access or, more importantly, a single clearing access … So, they can do cross margining, long-short trades, cross-spreads, etc. … they want to have that all in one place because it’s much more capital efficient. (Hong Kong, 30 July 2017).
These ‘network effects’ are very difficult to achieve for newcomers, which has led to a massive concentration of infrastructures within a handful of global exchange groups. This is a very profitable business model with profit margins of over 50%, by far beating other financial institutions. As the CEO of an alternative trading system commented on exchanges’ new business model:
I mean if you have a listing, then you have an index, you have the trading, you have the clearing, then you have the settlement. It makes it very difficult for a company to move away from that, so it’s a very sticky business model. (London, 11 October 2017).
While exchanges are somewhat limited by competition and regulation, providing complementary infrastructural arrangements solidifies the structural power of global exchange groups.
Today, exchanges are profitable global corporations whose business is to provide, govern and control large parts of global financial infrastructures. As demutualised, self-listed, profit-driven and globally active technology companies, they have become powerful actors that actively create, regulate and shape (electronic) markets around the world and across asset classes.
By providing infrastructures for capital markets, exchanges enable the functioning of these markets. But their new role as infrastructure providers also put exchanges in a position from which they can potentially exercise structural power over companies, investors and states entangled in these infrastructures. Power that is concentrated within global exchange groups who dominate the majority of global capital market infrastructures. By looking at exchanges as global infrastructure providers instead of merely national marketplaces, their importance as powerful actors in the politics of global finance becomes apparent. Hence, through highlighting the structural power of infrastructure providers the paper contributes to current IPE debates on infrastructural power that more often focuses on the relational entanglements of states and (financial) markets.
As organisers of capital markets, exchanges should be concerned with the long-term stability of markets. However, most exchanges are now profit-driven businesses, while wielding substantial power over global markets. This is an important contradiction at the heart of exchanges because their roles as market organisers and market actors have conflicting incentives. Especially as this power is concentrating within a few entities, this raises important questions about whether exchanges create new systemic vulnerabilities in the global financial system – for instance by creating HFT infrastructures that contribute to repeated flash crashes or by concentrating systemic risk within a few CCPs that have incentives to lower margin requirements to attract new clients. While their own business models become more short term-oriented, what consequences does this have for the markets they organise?
Markets do not emerge out of a vacuum; they are created by actors such as exchanges. However, over the last decades exchanges have changed fundamentally and have become powerful actors in global finance. As crucial building blocks of global finance, their transformation requires further investigation.
Johannes Petry is a PhD candidate in International Political Economy at the University of Warwick researching the development of Chinese capital markets and their integration into global finance, with a focus on the role that exchanges play as crucial actors in processes of capital market development. He is a co-founder and organiser of the Warwick Critical Finance Group.