In the midst of the high frequency trading debate, many are also decrying the for profit exchanges model. However, for profit exchanges had nothing to do with the advent of HFT. HFT would have been here with or without them.
There was a reason for exchanges to go for profit. They were going broke being mutually held. When an operation is run at break even, it loses money. Exchanges had to make gigantic investments in technology if they were going to maintain relevancy. If exchanges hadn’t gone for profit, the ones you know so well today would be relegated to the dust bin of history.
I was an early advocate at the CME of going for profit. We were a mutually held organization. I was a member of the CME Board of Directors when we switched over. It took from 1998 to 2001 to actually do all that was necessary to change the direction of the exchange. Members voted to change it. The members of that board voted to have run off elections to shrink the size of the board, from 40 to 19 people, in preparation of becoming a public company.
All that being said, I don’t think exchanges are perfect. There is a lot wrong with our marketplaces, but it doesn’t start at the exchange level. It starts at the regulatory level. Exchanges have lost touch with many of their constituencies, and don’t have the same market savvy they once did. They have lost their focus at providing a level playing field and a good market in the name of greater volume. But, their existing structure is still better than their prior non-profit mutual structure.
To give you some idea of how exchanges functioned before being public and for profit, I will try to illustrate a couple examples.
Exchanges had membership structures. The CME had over 230 standing committees staffed by the membership that oversaw the executive staff of the exchange. Members had to approve everything at a committee level, then a board level to get things done. The easiest way to think about it is to use the metaphor of government. Elected officials oversee the bureaucracy. Same at an exchange. I was elected by my fellow members to run the place, along with 39 other board members. Different divisions, products, and of course, constituencies.
Because of IRS tax rulings, there is still a remnant of the member structure left at many exchanges. You can still lease a seat and save money on fees. But management runs the place, not the members.
If you think that members worried only about fair markets, you are seriously mistaken. They worried about their pocketbooks every bit as much as anyone else would and exchange politics could be brutal. Exchanges were seriously bureaucratic.
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