We had the opportunity to meet the management of over a dozen global exchanges, e-brokers and fin-tech firms at a recent conference in New York. Global exchanges and e-brokers have benefitted from multiple secular, regulatory and cyclical tailwinds in recent years, which have resulted in strong growth trajectory and robust stock returns. The Hamilton Capital Global Financials Yield ETF (HFY) [1] has ~4% exposure to exchanges and e-brokers, while the Hamilton Capital U.S. Mid-Cap Financials ETF (USD) (HFMU.U) has ~3% exposure. These financials sub-sectors have provided the ETFs with diversification benefits and helped reduce return volatility while providing exposure to structural tailwinds.

Below are our key takeaways:

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  • E-brokers: Tougher rate environment and increased competitive intensity to drive consolidation
    The large U.S. e-brokers we met were optimistic about asset growth and scale related competitive advantages long-term. In particular, the growth of the independent advisor channel (mostly breakaway teams from the large wirehouses) is expected to remain a key tailwind for asset growth. However, near-term, senior management teams were expecting a slowdown in asset growth from recent market volatility, resultant risk-aversion and lower interest rates.Competitive intensity remains high from both traditional competitors (large asset managers, banks) as well as new entrants (low-cost robo-advisors). After a decade of commission cuts across the industry, the e-brokers informed us that pricing flexibility remains an important tool for client retention. Robo-advisory AUM remains small but with rapid growth, especially among a digital-first investor base, these firms could become more meaningful competitors long-term.Overall, the industry continues to move towards a full-service advisory platform.  E-brokers remain active acquirers of smaller competitors as a means of consolidating AUM/market share, improving operational efficiency and growing across the investing value chain.
  • Exchanges: Oligopolistic sector continues to enjoy robust organic and acquisition-driven growth
    The global exchange sector remains supported by multiple secular and regulatory tailwinds. Consolidation over the past two decades has resulted in the three incumbent exchanges (ICE/NYSE, Nasdaq and CME) dominating market volumes across most major asset classes (equity, credit, currency and commodities among others). Regulatory changes introduced since the financial crisis have also helped drive market volumes into exchange traded products. Rapid trade electronification (particularly in fixed income – a large, traditionally voice dominated asset class), secular demand for indexed products, data & analytics along with international expansion have been other growth drivers.According to exchange executives, both policy and investing backdrops remain more conductive for U.S. exchanges than their European counterparts. In the absence of policy certainty on Brexit negotiations, European market volumes have begun migrating (albeit slowly) away from the U.K. to the Eurozone, U.S. and even Asia in some cases. European exchange executives stressed that any large-scale industry consolidation would have to wait until after Brexit negotiations. In the interim, rapidly growing demand for data and indexed products from investment managers, trading firms and other market participants continues to support growth and margins.…but the SEC scrutiny could impact pricing power negatively amid rise of new age competitors
    While the regulatory backdrop remains favourable for global exchanges, the U.S. Securities and Exchange Commission’s (SEC) recent scrutiny of data fees[2] and fee rebates/incentives[3] has raised regulatory risk for the sector. Regulatory review of data & connectivity pricing has the potential to impact exchanges negatively as it is a high growth and high margin business for the incumbents.
  • Fin-tech competitors are at a nascent stage and focus on niche market opportunities: The e-brokers and exchange sectors have seen a steady influx of competitors in recent years attracted by their high ROE, low regulatory/compliance burden and an easier fund-raising environment. According to the incumbents, competition remains high, particularly in the robo-advisory channel, although most new entrants lack scale.The U.S. exchange space has also seen new entrants over the past year, but competitors are still in the early stages. Entrants face strong pushback from incumbents in the form of fee rebates/incentives and entrenched market shares.

Notes

[1] 4.07% dividend yield, as at June 30 2019.
[2] On May 21, 2019 the SEC asked exchanges to improve disclosures on data and connectivity fees. The disclosures would include https://www.sec.gov/rules/final/2018/34-84875.pdf
[3] On December 19, 2018 the SEC announced a transaction fee pilot (“pilot”) program to analyze the impact of fees/incentives on order flows and trade execution. https://www.sec.gov/rules/final/2018/34-84875.pdf. The pilot has since been put on partial stay by the Commission after the 3 major U.S. exchanges – Nasdaq, CBOE and NYSE – sued the SEC.

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