Adverse Self-Selection and the Changing Competitive Balance between Stock Exchanges and Off-Exchange Trading Venues

Erik K. Clemons and Bruce W. Weber
International Journal of Electronic Commerce
Volume 1, Number 3, Spring 1997, pp. 21-42.

Abstract: Advances in information technology will fundamentally change the basis of competition between securities markets. Competition will require the development of new strategies for the exchanges, their intermediaries, and their customers. The implications of off-exchange trading systems for exchanges and most especially for their member firm intermediaries will be larger than loss of market share alone would suggest because these systems are differentially more attractive to those customers who have represented the greatest source of profits for traditional securities exchanges and their intermediaries. Exchanges will have to develop new marketing strategies, more reminiscent of competition for retail financial services than of monolithic trading markets. Development of these new competitive strategies will not be easy for the London Stock Exchange. Naive actions taken by intermediaries to preserve their market share run the risk of destroying member profitability or destroying the Exchange’s market share. Similarly, naive actions that could be taken by the Exchange run the risk of disintermediating member firms and thus would be resisted. Strategies do exist that preserve the central role of the Exchange and the profitability of its intermediaries; however, these strategies are complex and politically difficult to implement since they require fundamental changes to the pricing strategies of the Exchange and of its members.

Key Words and Phrases: market intermediaries, off-exchange trading, securities markets, stock exchanges.