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While the merger of NYSE Euronext Inc. and IntercontinentalExchange Inc. (ICE - Analyst Report) is in the advanced stages of culmination, the latest merger pact between BATS Global Markets Inc. and Direct Edge Holdings is the next potentially strong business combination in the US to have snatched the limelight.

Although the terms of the deal remain undisclosed, the merger between BATS and Direct Edge is expected to close by the first half of 2014, once the regulatory approvals are attained.

Based in Kansas and formed in 2005, Better Alternative Trading System (BATS) is the third largest securities exchange in the US that operates through the BZX Exchange and the BYX Exchange, accounting for about 12% of total equity volumes in the US. Apart from equity trading, BATS offers market data and listing services. It is also the largest pan-European equities trading hub with multilateral trading facility, operating as BATS Chi-X Europe.

On the other hand, New Jersey-based Direct Edge ranks just next to BATS and operates via two stock exchange platforms − EDGA Exchange and EDGX Exchange. Meanwhile, both BATS and Direct Edge are held by consortiums of investment banks and high-frequency trading companies such as JP Morgan Chase & Co. (JPM - Analyst Report) and Goldman Sachs Group Inc. (GS - Analyst Report).

Opportunities Galore

The companies in the merger intend to expand the listing business and market data offerings in the US. Furthermore, BATS and Direct Edge seek to capitalize on the fresh opportunities in the underpenetrated markets of Canada and Japan.

We believe the effect of the potential merger on the global markets is likely to be significant as it would raise price competition in the equities markets of the US. The merger is likely to benefit from the economies of scale as the parties aim to lower cost of expensive technology from the amalgamation of the four exchanges.

Further, this merger is expected to gain competitive edge over other exchange giants such as NYSE and Nasdaq OMX Group Inc. (NDAQ - Analyst Report) through strong volumes generation. Currently BATS holds a market share of about 10% in terms trading volumes, while Direct Edge owns about 11%. Accordingly, the merged company is projected to be only second to NYSE, which has 23% stake in the market, beating Nasdaq (holding 18% market share) and CBOE Holdings Inc. (CBOE - Analyst Report), among others.

Challenges Ahead

However, the proposed merger has its share of challenges too, the primary being controlling costs and handling technical glitches. While a roar of merger and acquisition activities were witnessed in the past couple of years, most of them never saw the light due to the regulatory and operational snags. BATS is also facing diminishing volumes for over 4 years now and its bid for an initial public offering (IPO) also failed last year.

Nevertheless, Hong Kong Exchanges & Clearing Ltd. bought the London Metal Exchange Ltd. for $2.2 billion last year, while Tokyo Stock Exchange merged with Osaka Securities Exchange to diversify into derivatives early this year.

It’s a waiting game now to find out if the merged entity will be able to sustain the competition as the much-awaited $10.2 billion merger between NYSE and IntercontinentalExchange may create additional competitive pressure in the market. Thus, we remain on the sidelines to analyze the future of this merger amid current market conditions.

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