Market structure is like plumbing. You don’t really think about it until you have to. Same goes for stock exchanges. You can place a trade on Robinhood and completely forget about all the work that goes into you actually owning the stock.
I’ve done more reading on market structure because lately I’ve gotten more interested in the plumbing of the capital markets. Market structure might mean different things to different people. When I talk about “market structure” I’m referring to the institutions and regulations that govern them that allow you and I to trade a security.
Nobody likes a middleman, but stock exchanges are an important one for the same reason Etsy is. Without Etsy, it’d be a lot harder to find that bathtub caddy that lets you drink wine and watch Love Island. Without a stock exchange, we’d probably be trading stock on Craigslist or asking our Facebook friends who’s selling TSLA (that’s Tesla’s ticker for non-finance people).
Taking the Etsy example a little further, what if we found out that there’s actually 56 Etsies (I think I’m the first to pluralize Etsy) to trade that bathtub caddy? Well, that’s exactly what our current market structure looks like in the U.S.
There are 16 registered stock exchanges and 50 alternative trading systems on which to trade a company’s shares . And that doesn’t include the internalization that can happen if a broker-dealer trades against its own inventory. All in all, you’re looking at a whole lot of trading venues that your order can be placed at.
Alternative trading systems (“ATSs”) are interesting because they’re commonly referred to as dark pools. A dark pool is a trading venue whereby the price and size of an order is not publicly displayed prior to execution. So if you wanted to place a large sell order, dark pools are enticing because the market won’t know your intention and trade against you, driving the stock price down. The opposite of this would be a lit pool which does show the price and size of every order. ATSs are in the business of matching buyers with sellers through a combination of fee incentives, low latency technology, and anonymous trading.
Stock exchanges operate both dark and lit trading. But they go beyond ATSs because they are self-regulatory organizations that allow companies to go public by listing their shares on the exchange. Once listed on an exchange, the newly public company must follow strict reporting and governance rules dictated by the exchange. In return, stock exchanges offer a place for private companies to raise capital from the investing public. Going public is often a once-in-a-lifetime event for entrepreneurs and the single greatest opportunity for founders, early employees, and early investors to cash in on a startup’s success.
Let’s take a look at the 16 U.S. stock exchanges actively registered with the SEC (last updated October 2020). To make sense of why the U.S. has so many stock exchanges, I gave each exchange its own value proposition based on what was marketed on their public websites.
|Short Name||Value Proposition|
|IEX||Created to protect orders from being “picked off” by high frequency trading firms through technologies like the Speed Bump. Primarily benefits large institutional orders in which small changes in price can have a large impact on P&L (profit and loss)|
|MEMX||Offers a trading venue with low fees and low latency technology formed by a coalition of financial institutions that are tired of exchange holding companies (ICE, Nasdaq, Cboe) dominating the market structure landscape|
|MIAX||Ultra low latency trading built off MIAX’s existing technology infrastructure with a competitive fee schedule|
|LTSE||Enhance the public capital markets by focusing on the long-term value of a company. LTSE plans to do this through a combination of exchange policies geared towards long-term governance and a coalition of long-term investors|
|NYSE||The top exchange by market share. Globally recognized brand. NYSE uses a DMM (Designated Market Maker) which is essentially a bunch of human traders helping to oversee orderly trading of the securities they’re responsible for making markets in|
|NYSE MKT (a.k.a. NYSE American)||Primarily supports small-cap stocks by leveraging the NYSE brand and an eDMM (electronic Designated Market Maker) to enhance liquidity|
|NYSE Arca||Top U.S. exchange for listing and trading of ETFs|
|NYSE National||Uses a “taker-maker” fee schedule that provides a rebate to those who remove liquidity and charges a fee to those who add liquidity. So a trader get a rebate on a market order and charged a fee on a limit order. Primarily aimed for fee-sensitive investors taking liquidity or passive investors trying to minimize their time-to-fill (i.e. how long it takes for your limit order to get executed)|
|NYSE Chicago||Offers unique features ideal for hedge funds and institutional brokers. It’s unclear on their website exactly what those features are|
|Nasdaq||Second largest exchange by market share. Popular for tech companies, The Nasdaq Stock Market is unique in that it has also has its own stock index. The Nasdaq 100 Index is comprised of the 100 largest non-financial companies listed on The Nasdaq Stock Market. You can invest in the index via index-based ETFs like QQQ|
|Nasdaq PHLX (PSX)||Combines a price/time priority model with a pro-rata model. In a price/time priority model, the trade with the best price is ranked first. After price, trades are ranked by time they were entered. In a pro-rata model, trades are ranked by price, then allocated equally based on size. This incentivizes larger orders to be placed on PSX when the trading queue for the stock is backed up at other exchanges|
|Nasdaq BX||Similar to NYSE National, Nasdaq BX offers a taker-maker fee schedule|
|Cboe BZX||Uses a price/time priority model with a maker-taker fee schedule. A maker-taker fee schedule is the opposite of the taker-maker fee schedule used by NYSE National. It gives a rebate to those who add liquidity and charges a fee to those who remove liquidity|
|Cboe EDGX||Uses a price/time with retail priority model combined with a maker-taker fee schedule. Not clear on their website or annual report how this model functions|
|Cboe BYX||Uses a prime/time with price improvement for retail customers model combined with a taker-maker fee schedule. Not clear on their website or annual report how this model functions|
|Cboe EDGA||Uses a price time priority model with a taker-maker fee schedule|
One thing I noticed is that several exchanges offer a value proposition that is primarily based on fee incentives. An exchange whose biggest value proposition is a fee incentive is probably more interested in order flow from trading firms. Contrast this with the Long-Term Stock Exchange (LTSE), which boasts no fees or rebates and requires member firms to fully display prices on their orders.
LTSE’s value proposition is a bold one, and it’s no surprise that it comes out of Silicon Valley. Founded by Eric Ries, author of The Lean Startup, LTSE wants to reform capitalism by helping its listed companies focus on long-term value instead of short-term results. Given the number of publicly listed U.S. companies has gone down 46% since its peak in 1996, Reis might be sharing some widely held opinions on the U.S. capital markets .
I read LTSE’s research paper and it will be very interesting to see how it plays out in the long run (it will be very ironic if this exchange is short-lived). The exchange will require listed companies to adopt and publish five policies:
- Who does the company consider its long-term stakeholders and what role does the company play relative to them
- What is the long-term strategy of the company and what time frame does the company consider when making strategic decisions
- What are the long-term success metrics of the company and how will its executive and board compensation align with those metrics
- How will a long-term oriented board of directors engage with the company and oversee its long-term strategy
- How will the company engage with long-term shareholders
While no company has listed on LTSE yet, the first company to do so will be an interesting case study. I do think this is a step in the right direction for American capitalism, but changing America’s short-term orientation will not happen overnight. The American people are short-term oriented in general. We like 60 second TikTok videos and 280 character Twitter posts. Our median years of tenure with an employer is 2.8 years for workers aged 25-34, which is part of a decreasing trend in the past decade .
LTSE’s business model will help raise awareness for who a company’s long-term stakeholders are, which is an important first step in companies becoming more active participants in their communities and how their decisions impact more than just their bottom line. It remains to be seen whether this will influence other exchanges in updating their policies for the companies that publicly list with them. My hope is that it does. If we want to live in a more sustainable world in the future, we cannot just rely on not-for-profit organizations or Elon Musk to lead the way. I think most, if not all of us, want to work for organizations that are transparent about their operations and the impact they have on the environment and society at large. Stock exchanges can certainly play a role in facilitating the ethical creation of value in our public capital markets.
Looking ahead, more transformation is on the way in U.S. market structure, beyond just stock exchanges. NYSE’s parent company Intercontinental Exchange (ICE) recently acquired Ellie Mae, which helps automate mortgage lending. ICE’s goal is to fully automate the mortgage lending process from origination to closing, drastically reducing the time and cost to close on a house. In addition, blockchain poses an exciting new future for the tokenization of securities and what that means for securities settlement. Currently it takes two days for a stock to settle into a brokerage account after purchase. Blockchain could potentially reduce that time from two days to one, or even same day settlement.
I included some resources at the bottom of this page for anyone that’s interested in learning more about market structure and the business model of stock exchanges. Overall I find this stuff pretty fascinating especially as I get deeper into my career in finance and what kind of work I want to be involved with in the future.
I’m always interested in hearing others’ ideas about these topics, so if you have a question, comment, or article you find interesting, please feel free to share it in the comment section!
 https://www.finra.org/filing-reporting/otc-transparency/ats-equity-firms for Equity ATS information. Excluded any ATS that has ceased operations as of the date of October 2020. https://www.sec.gov/fast-answers/divisionsmarketregmrexchangesshtml.html for exchanges registered with the SEC. Exchanges primarily trading stock were verified with https://iextrading.com/apps/market/.
 Data sourced from The World Bank. 8,090 domestic companies were listed as of 1996. 4,397 were listed as of 2018.
 U.S. Bureau of Labor Statistics, https://www.bls.gov/news.release/pdf/tenure.pdf, September 2020.
Changing Business Models of Stock Exchanges and Stock Market Fragmentation by the Organization for Economic Co-Operation and Development for the OECD Business and Finance Outlook 2016
International Review of Equity Market Structure Regulation by the Program on International Financial Systems
Sustainability Accounting Standards Board, an organization that sets standards for reporting the financial impacts of sustainability