Cost efficiency in financial exchanges and post-trade infrastructures: a closer look at integration and product diversification

Since the end of 1990s, financial exchanges and post trade infrastructures (FEPTIs) have gone through consolidation via mergers, acquisitions and restructuring. We explain the economies behind these events and propose the best performant consolidation way for the industry. To do so, we first classify these consolidation events into business integration and diversification models. Then, we analyze effects of these events on the efficiency of FEPTIs. We assume that FEPTIs are transaction processing factories and measure their efficiency in terms of total cost, average cost (short-run efficiency) and scale elasticity (long-run efficiency) through frontier and random-effects panel regressions. We find that any integration reduces costs in the long run. Horizontal integration is the most cost-efficient integration model in the short run for both derivatives and securities markets. In the long run, horizontal integration is still the best model for derivatives markets, while a vertical silo model or multiway integration are more suitable for securities markets. The results also reveal regional differences. In emerging markets, entity size is the only significant factor for efficiency. Our results yield important implications for policy makers, financial exchanges, and post-trade infrastructures in terms of market design and consolidation, in both developed and emerging markets, from both short- and long-run perspectives, and for infrastructure providers of both securities and derivatives markets.