NYSE introduced its RLP program on August 1^st of 2012. Other for-profit exchanges have since followed in its footsteps – most notably NASDAQ OMX. Since mid-February, when NASDAQ introduced its own RPI program, it has been executing those trades at a loss in an attempt to regain market share it had lost in the past year. It has been doing so with a more aggressive rebate schedule than NYSE as well. NYSE intends to respond with its own more aggressive rebate schedule. A price war. Yay.

Since REG NMS brought about a few initial bounty years (2007-2010), for HFT firms and the stock exchanges, those years have been followed by dramatically declining cash equity trading volumes. Apparently, the exchanges never accounted for the possibility that the multi-tiered market structure that they were busy creating would drive away investors.

Since those initial bubblicious years, the exchanges have been feverishly trying to stem that trend using additional step-up rebate tiers, new retail segmentation/internalization/pricing schemes, and even 50% off colocation “after-Christmas sales”. Today, exchange executives probably feel foolish for in the past projecting out years of colocation revenue growth. Today, their cash equity trading businesses have become throw-away businesses. At NASDAQ for example, US cash equity trading makes up a paltry 7% of revenues, and loses money. Today, exchange officials probably feel foolish for trapping themselves in a downward margin spiral maker-taker pricing model.

One of our issues with modern market structure is that we are not sure the for-profit thing works real well with stock exchanges. When exchanges instituted flash order types, knowing that they were unfair and bad for investors, they subordinated investor fairness and good to short term profits. When exchanges also developed complex order types that allowed for “glitches” and queue-jumping, they also subordinated investor fairness and good to short term profits. When exchanges developed and sold enhanced data feeds that leaked participants’ order information, they again did the same thing – and do so to this very day.

We listened to CEO Greifeld address a CSFB Miami Conference audience last week. He commented that 2013 would be a muted year transaction/volume wise, and he attributed that to a muted economy – he said the business of a stock exchange inevitably is tied to the general economic conditions in the economy. He also said he was pleased that NASDAQ had diversified away from its stock trading businesses to add value as service providers in other areas. He made no connection or acknowledgement that the current conditions could be, at least in part, due to the very decisions NASDAQ had made over the prior decade.

The exchanges have trapped themselves into a conundrum by aligning their profits so strongly to the health and success of hyper HFT scalpers and market makers, who themselves feel the margin pressure and pain. They must continually improve these HFT firms’ margin situation if they want those very firms to buy the data feeds, technology services, and colocation space the exchanges are selling. And so the downward spiral continues. Cash equity trading bleeds more each day, offset in the short term by growth in derivative trading, which will likely, eventually, follow the same path as the US equity space.

This begs the question: Will the for-profit stock exchanges reach a point where they choose to abandon stock trading all together, as it loses money, and they have a responsibility to their shareholders to NOT do that? Who will list public companies then? Who will be responsible for ensuring an efficient and fair secondary market, which is the backbone for equity capital-raising, and economic growth for the globe?

Will anyone be there 10 years from now? Or will we witness server-farm going out of business sales.