Exchanges are firms that have established markets in some type of financial product. They facilitate the buying and selling of different forms of property. Financial markets have a long history beginning with informal markets during the Middle Ages. Traders often met in informal settings to buy and sell crops, clothing, and even land. Markets later expanded to include paper securities such as stocks and bonds.
The emergence of nation-states in the seventeenth and eighteenth centuries facilitated the development of exchanges. One of the earliest financial revolutions in modern Europe was created by the wartime demands of Emperor Charles V and the Habsburg Netherlands in 1542. The monarch used the Amsterdam exchange to issue and sell debt. In this fashion, governments were able to raise capital to finance wars. Secondary markets for government obligations eventually expanded to include stock and bond issues by quasi-governmental companies as well as joint-stock companies. The Dutch and British East India Companies, for example, used capital markets to finance trade around the globe and expand capitalism.
Early American Exchanges
Securities trading in the United States began with the redemption of government bonds following the American Revolution. Trading was eventually sufficient that brokers and dealers also began to specialize in buying and selling bonds and securities issued by public companies. Some of these brokers signed an agreement on 17 May 1792 in New York City to set minimum commission rates. This so-called Buttonwood Tree Agreement is generally considered to be the founding of the New York Stock Exchange.
New York City brokers established a more formal structure for trading following the War of 1812. Dealers created the New York Exchange Board in 1817 and agreed on a constitution that provided for the annual election of a president and secretary. Years later, the board changed its name to the New York Stock Exchange (NYSE) and in 1863 constructed its own building. Six years later the NYSE merged with a rival, the Open Board of Brokers. The new NYSE delegated power to a central governing committee that retained the right to discipline and expel exchange members.
The Multiplication of Exchanges
In the mid-to-late nineteenth century, stock exchanges also formed in most large American cities to raise capital for local companies. Vibrant exchanges emerged in Boston, Philadelphia, San Francisco, Los Angeles, Baltimore, and many other cities. By 1890, there were approximately one hundred regional exchanges. The scope of exchanges also expanded. The Chicago Board of Trade, formed in 1848, provided a commodity market for midwestern farmers. Produce and cotton exchanges emerged in New York City to deal exclusively in produce and cotton. Markets for sugar, coffee, and even eggs and butter emerged to trade specialized goods. The introduction of futures and options contracts on these exchanges allowed investors to hedge their risks in financial markets.
Technological advances, however, limited the growth of regional exchanges. The telegraph and telephone facilitated the flow of information, aiding in the integration of securities markets and spurring the rapid growth of national exchanges. By the late nineteenth century, the New York Stock Exchange had emerged as the leading market in American securities. The Big Board accounted for nearly 70 percent of all stock transactions carried out on organized exchanges. The curb market, which began in the 1790s and was the precursor to the American Stock Exchange (AMEX), assumed a greater roll on Wall Street in the early 1900s to provide additional trading in emerging national companies. The Chicago Board of Trade assumed a similar and dominant role in commodity markets.
Technological change also fostered competition between stock exchanges. The Consolidated Stock Exchange of New York, formed by a merger between the Mining Stock Exchange and the Petroleum Exchange, emerged as a competitor to the NYSE in 1885. The Consolidated decided to compete head-to-head with the NYSE by trading leading railroad and industrial securities. The Consolidated used the telegraph to transmit quotes from the NYSE to its own trading floor. By the early 1890s, share volume on the Consolidated averaged approximately 50 percent of NYSE volume.
The Big Board challenged the Consolidated's practice of "stealing" NYSE price quotes. A twenty-year court battle ensued between the two exchanges over ownership of price quotations in security markets. The courts ultimately decided that price quotes were private property and that the NYSE was not obligated to supply them to its competitors. The ruling affirmed the dominance of the NYSE and played an important role in the demise of the Consolidated Stock Exchange. Nevertheless, the Little Board provided the NYSE with a rivalry unprecedented in the history of American markets.
Regulation
Except for some key court decisions, securities markets were largely self-regulated before World War I. Exchanges were responsible for establishing and enforcing rules and regulations for their members as well as setting commission rates on transactions and it was generally felt that this was the way it should be. Commodity markets, however, were an exception. Concerns over insider trading, wash sales, and the manipulation of futures trading prompted the regulation of commodity exchanges. Congress passed legislation in the late 1910s and early 1920s to regulate futures trading in grain and cotton.
The stock market crash of 1929 and the Great Depression prompted regulation of the banking and financial sectors. Many felt that the close links between commercial banking and the marketing of corporate securities exacerbated the country's economic downturn. In 1933 Congress passed the Glass-Steagall Act (Banking Act), which separated the activities of commercial and investment banks. The government authorized the Federal Reserve to set margin requirements, the amount of capital required to purchase securities on credit. Congress also passed the Securities Act in 1933 and the Securities Exchange Act in 1934. The 1934 legislation created the Securities and Exchange Commission, a regulatory body that established uniform accounting standards and tighter listing requirements and monitors trading activity on registered exchanges.
Regional Exchanges Versus the Principal Exchanges
Government regulation following the crash of 1929 significantly affected the role of regional exchanges. The Securities Exchange Act raised listing standards, especially for regional exchanges since relatively low-profit companies traded on local markets. Higher standards further eroded business on regional exchanges by inducing smaller firms to trade on the unregulated over-the-counter market.
Although the SEC initially drove business away from regional exchanges, subsequent legislation helped the regional stock exchanges compete for business with the NYSE. Congress amended the Securities and Exchange Act in 1936 to allow registered exchanges to trade listed securities as unlisted provided there was an active market for the security on a principal exchange, the NYSE or the AMEX. The provision allowed struggling regional exchanges to trade NYSE-listed stocks.
The amendment introduced competition between regional and national—the NYSE and AMEX—equity markets. In response, the NYSE created a special committee to investigate the practice by which its members traded on multiple exchanges. On 28 February 1940, the committee proposed that the NYSE enforce the provision of its constitution that prohibited members from multiple exchange trading on pain of expulsion or suspension. On 12 July 1940, the NYSE voted to begin enforcing the multiple trading rule after 1 September 1940.
The SEC opposed the Big Board's decision to restrict its members from engaging in multiple exchange trading. Federal regulators had requested the NYSE to rescind the rule on two separate occasions late in 1939. The NYSE refused in both instances, prompting the SEC to hold hearings in January 1941 to investigate the practice of multiple exchange trading. Presidents of several regional exchanges testified about the likely effects of such a rule. The president of the Boston Exchange argued that prohibiting multiple exchange trading would cause 25 percent of their dually listed securities with the NYSE to be without a dealer. Representatives from the Pittsburgh and Cincinnati Exchanges believed that the provision threatened their very existence. The SEC ultimately ruled in favor of the regionals and forced the NYSE to abrogate its prohibition by October 1941.
Regulatory decisions by the SEC, along with technological advances, changed the business practices of regional exchanges as they began to compete head-to-head with the Big Board for business. Listings on regional exchanges began to decline as these markets began trading NYSE-listed stocks. In 1938, regional exchanges accounted for 37 percent of listings on registered exchanges, slightly more than either the NYSE or AMEX. By 1995, regional listings represented less than 10 percent of the total listings on regional exchanges. Regional stock exchanges also introduced new business procedures and even extended trading hours. They gave rebates, expanded membership, and used other means to attract business away from the NYSE.
Head-to-head competition between regional and national markets also led to mergers among regional exchanges. The Midwest Stock Exchange was created in December 1949 following the merger of the Chicago, Cleveland, and St. Louis Stock Exchanges. New Orleans joined the Midwest Exchange in 1959. The Los Angeles and San Francisco Exchanges merged to form the Pacific Stock Exchange in January 1957. Philadelphia and Baltimore consolidated to create the Philadelphia-Baltimore Exchange in March 1948. Washington and Pittsburgh joined the merger in 1953 and 1969, respectively, making it the Philadelphia-Baltimore-Washington Exchange. From 1940 to 2001, the number of regional exchanges fell from eighteen to five. Mergers allowed regional exchanges to capture market share at the expense of the NYSE during the last half of the twentieth century. Regional market share increased from 5 percent of transactions on registered exchanges in 1934 to nearly 15 percent by the end of the century. Mergers appear to be one more example of a competitive device employed by regional markets to compete with the NYSE.
New Regulation, Technological Advances, and Internationalization
The 1970s ushered in a new era of regulation and technological advances. The Securities and Exchange Commission forced the NYSE to deregulate commissions to encourage greater competition in financial markets. Congress created the Commodities Futures Trading Commission (CFTC) to oversee the regulation of futures markets. Exchanges introduced new financial products such as derivatives and new option products to give investors greater ability to hedge their risks. A national computerized trading system was also introduced.
The last two decades of the twentieth century have seen the internationalization of securities markets. More than ever before, American exchanges operate in a global marketplace. Political and economic liberalization in many countries, along with advances in computer and telephone technology, have led to greater integration among world markets. It appears that this trend will continue as long as information costs continue to decline.
Since the American Revolution, U.S. markets have experienced tremendous changes brought on by technology, economic conditions, and political influences. Markets grew in importance during the nineteenth and early twentieth centuries with American industrialization and pathbreaking technological changes. The importance of markets waned during the interwar years and the first few decades following World War II. By the end of the twentieth century, however, American markets had reemerged and taken on a larger importance in the economy and society. Computerized trading systems and the nearly instantaneous flow of information have permanently changed the nature of markets. American exchanges operate in a global marketplace and compete for business with leading markets around the world.
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—Marc D. Weidenmier
