Exchanges is a place where buyers and sellers come together to trade these things like stocks, currencies, and even commodities like oil, in a safe, organized way.
When I was researching
for Hong Kong investment opportunities, I stumbled upon Hong Kong Exchange
(ticker: 0388). I had a flashback on those HK dramas that related to stock
market, like Divine Retribution (世紀之戰) and The Greed of Man (大時代).
Putting aside my nostalgia, I did learn a few things about exchanges and
their economic moat.
So, let’s start with…
Toll-like Revenue
If you want to trade
financial products, chances are you must buy them through an exchange, directly
or indirectly. There is no way around this. Hence, they earn their revenue
through all transaction fees.
Yet… this “toll-like”
revenue is established through a few factors.
Barriers to entry
While in some
countries, like Singapore’s SGX and Hong Kong’s HK Exchange, there is only 1
exchange, which gives them an almost monopoly-like business in their country.
Most countries have
high capital requirements and uphold certain standards to ensure the exchange
function as it should be.
Apart from functioning
as intended, should another company wish to set up another exchange, that
company need to show a business plan to the country government to explain the
need of another exchange.
Hence, it isn’t as
simple as having the capital to obtain the license.
For HK and Singapore
here are some links to read if you are interested in the requirements need to
open and maintaining the exchange:
HK SFC requirement: https://www.elegislation.gov.hk/hk/cap571?xpid=ID_1438403465394_001
Intangibles – Data
There will
be an ocean size trove of data available for interested parties to analyses, to
make sense out of it, etc.
Traders
will want fast accurate data depending on their trading style, as some of them
believe the speed of data matters to their prosperity. Investors probably wish
to know other information like the companies’ management transaction and
announcement. They want this information to be timely and wholesome. Brokers
need this data to implement into their platforms and let their clients use
them.
And who has
this firsthand data to give them? Spoiler alert: Exchanges.
Data like
Real-time quotes, corporate data, order book data, market news etc.
Exchanges
recognized that brokers and financial institutions want this data and are
willing to pay them.
Hence,
granting them another subscription-like income.
Intangibles – the country
matters
While the
exchanges have no part to play in this matter, the country’s reputation where they
reside matters too.
Imagine the
country’s bureaucracy is slow and inefficient, police do not do any enforcement
at all, and law is just a book.
Investors
may not trust the listed companies’ financial reports. Companies may not wish
to list in that exchange. Even if the company does, it takes a long while to
get it.
Should
there be any white-collar crime, will there be anyone enforce it?
In the
opposite scenario, a country that has efficient bureaucracy, transparent and
clear laws with good enforcement. Companies and investors have a high trust in
the country and may consider listing or trading/investing in that exchange’s
listed companies or financial products.
This may
increase the volume of transactions, foreign capital flow into the exchange.
Some
exchanges may cater to a specific type of investment product and entrepreneurs
may choose that exchange to list in instead.
For
example, Singapore Tech Company, SEA LTD listed in NYSE instead of SGX and
Oversea REITS choose to list in SGX due to the high preference of dividend
stocks.
This leads
to another topic…
Their challenges
The high
barrier to entry created by regulations and their valuable intangible assets makes
them virtually unchallenged in their home country. Exchanges business isn’t
almighty.
Because
they may face…
Prefer to list in another
foreign country exchange
Like my
pervious example, SEA Ltd chooses to list in NYSE instead of SGX. This shows
that companies do have an option to list which exchange they prefer to.
Hence, it
isn’t a guarantee that a company will be listed in their home country exchange.
Certain
exchanges may have more diverse and deeper investor pools, providing access to
a wider range of potential investors than the domestic market. This can lead to
increased demand for the company's shares and potentially higher valuations.
While other
exchanges may attract concentrated pools of investors interested in the
company's sector or industry, leading to better understanding and valuation.
Depending
on the country’s tax law, foreign companies may get certain tax advantages.
Companies considering
listing may take these factors into consideration.
Government Policies may
affect exchanges
Sometimes the
government may impose policies for certain intentions well in mind. It doesn’t
mean the exchange may get the benefit.
Strict
regulations, complicated reporting requirements and unclear policies may
protect investors from several issues. But they may also deter companies from
getting listed, which reduces the exchanges potential.
For
example, US exchanges allow investors to buy a single share of the company,
allowing retail investors to invest in the company of their choice with little
capital. While SGX can only transact in terms of 100 shares (1 lot).
Almost a monopoly moat
Despite
facing challenges like cybersecurity threats and regulatory hurdles,
traditional exchanges offer several advantages, including asset-light
operations, healthy profit margins, and limited competition in certain markets.
Technological advancements in areas like trading platforms and data analytics
present opportunities to further streamline operations and attract new
investors or traders.
The rise of
cryptocurrencies has introduced new dynamics to the financial landscape. While
crypto exchanges strive to gain a foothold, the recent SEC approval of crypto
ETFs presents an indirect benefit for traditional exchanges. With their
established security infrastructure and extensive operational experience,
traditional exchanges can offer a safe and regulated platform for investors
interested in accessing crypto assets. This can potentially lead to increased
trading volume, broadened investor, and trader bases, and increase its revenue.
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