Concept of Private Exchanges

Bombay Stock Exchange (BSE), National Stock Exchange (NSE), New York Stock Exchange (NYSE), NASDAQ – We all must have heard these names, but PORTAL, Goldman Sachs Tradable Unregistered Equity OTC Market (GS TruE); probably majority of us might not have heard these names because these are exchanges which are out of bounds for retail investors, i.e. they are private exchanges.

Traditionally, whenever companies are in need of funds they hit the public markets and get listed on public exchanges. But recently there has been a trend of private exchanges being setup by big investment banks and other public exchanges as well. Goldman Sachs started its private trading platform in May this year and was followed by NASDAQ, which launched its own version, PORTAL. Many other big investment banks like Citigroup Inc., Lehman Brohers & Merrill Lynch have also established their own private exchanges.

In recent times, one of the big names in financial markets which decided to float on private exchange rather than on a public exchange is the alternative asset management firm Oaktree Capital Management LLC which raised $800 million by selling a 15% stake through GS TRuE. Furthermore Apollo Management, a private equity firm has expressed its desire to sell its shares on Goldman Sachs’ private exchange. American companies raised $221 billion last year by listing on private exchanges, which for the first time exceeded the amount raised through traditional exchanges. Globally this segment of securities market has touched $1 trillion.

Individual or retail investors are not qualified to trade on these exchanges, and are open only to large institutional investors. For example Goldman Sachs’ exchange is open only to institutional investors with assets of more than $100 million. Similarly Nasdaq’s portal is open to banks and insurance companies with at least $100 million in assets and brokers with at least $10 million in assets.

Its easy to understand why there is a rush towards private exchanges. Stocks of companies that trade in public exchanges need to be registered with Securities and Exchange Commission (SEC) and so are subjected to SEC regulations designed to protect individual investors. Additionaly such companies are open to a lot of scrutiny from regulators along with strict compliance with laws like Sarbanes-Oaxley Act (SOX), which requires numerous disclosures and adherence to other such regulations. So to save themselves from all such troubles the companies hit the private exchanges since stocks of bonds not registered with SEC (under Rule 144A) can trade on private exchanges. Many private equity firms and hedge funds which want to raise money but are reluctant to be lot more open to public prefer to be listen on private exchanges.

Though the amount of money a firm can garner is to some extent less on private exchange compared to public exchange primarily because the demand is much more on a public exchange. There is a growing criticism of private exchanges for the reason that they exclude individual investors from a growing proportion of financial market activity. Even the mutual funds that are main investment tools for individual investors, are allowed to trade in small number of unregistered securities thereby further alienating individual investors from market participation.

However still the idea that private exchanges might completely overtake public exchanges seems far fetched but its evident that they are going to snatch away a large chunk of their business. It would be interesting to watch this battle.