The gloves are off in the battle of the world’s stock exchanges. A new wave of consolidation among the leading players is just the first step as they gird for even greater changes that will probably cascade through the global securities industry.

The seeds were planted in the past few years as the biggest players demutualized and took themselves public. Consolidation then began in the U.S. with the NYSE Group Inc. ’s purchase of Archipelago Holdings Inc. and Nasdaq Stock Market Inc.’s acquisition of Instinet’s electronic trading network.

The NYSE and Nasdaq are now racing to become global players. Following the rebuff of a formal takeover offer, Nasdaq has accumulated a 25% stake in London Stock Exchange PLC. The NYSE, meanwhile, has agreed to a deal to acquire Euronext NV.

It’s not yet clear whether either deal will go through. Euronext is the subject of a competing bid by Deutsche Börse AG, and the NYSE may have to tiptoe through a political minefield to get its deal approved in Europe, which has often favoured local champions.

Meanwhile, Nasdaq’s stake in the LSE gives it a solid foothold on a global deal of its own. The LSE has seen a number of suitors over the years, but it’s not clear whether Nasdaq will make another bid for the whole thing. If nothing else, Nasdaq’s position blocks a NYSE-LSE deal and represents a solid investment.

There are also winds of change blowing throughout the trading business. Regulatory reform is coming to the markets in the U.S. and Europe that is expected to drive more electronic trading and lead to ever-thinner margins.

And regulators are grappling with the prospect of truly global exchanges, and puzzling over how they will regulate such markets. So far, they have done nothing to suggest they will try to block this. The U.S. Securities and Exchange Commission has issued a statement indicating that the NYSE and Euronext could merge without inviting U.S. regulation, particularly the onerous Sarbanes-Oxley rules, of European listings.

A merger between exchanges will probably be most effective if the firms can consolidate their listings on a common trading platform, allowing investors to trade their full joint roster of listings in multiple currencies and from any location. The regulatory paradigms will need to be adjusted if a truly global trading marketplace is to emerge.

Exchanges are also facing pressure to innovate from clients. Institutional investors are using more algorithmic trading, seeking greater trading anonymity and increasing demand for more sophisticated products. These forces are driving exchanges to evolve and competitors to emerge.

The catalysts already appear to be in play. In a report published in mid-June, CIBC World Markets Inc. initiated coverage on several U.S.-based exchanges and sketched out some of the shifts it sees taking place. “Our study shows the plumbing of the capital markets is undergoing a radical overhaul,” it says.

In the short term, CIBC predicts the new U.S. market rules, known as Reg NMS, should “markedly boost trading volume and liquidity in the equity and options markets.”

In the longer run, it points to “the growing sophistication of investors, evolving technology and disappearing borders” as fundamental factors altering the markets.

CIBC’s report suggests more sophisticated investors are leading the charge into new products as they seek large returns and better diversification. “This drive into new products gives an advantage to trading venues that can be levered across product classes,” CIBC says.

And investors are becoming more demanding about how they trade, as well as what they trade.

“The exchanges are in a technology race,” CIBC says. “We expect the growing use of algorithmic trading across all product classes will continue to drive the need for faster and more sophisticated electronic trading. The market participants that have not invested will not only get left behind but probably fall away.”

One example of the competition is Toronto-based Perimeter Markets Inc. , whose BlockBook service allows institutional investors to trade large blocks of stock anonymously.

Dreaming up new trading services or learning to live with rivals aren’t the exchanges’ only challenges. The CIBC report sees investors driving the demand for global trading. “We consider the end-game for the financial marketplace to be one [in which] equities and options will be traded by industry rather than region,” the report says.

@page_break@In some sense, it is part of the fallout from globalization. The leading companies in most industries have become global players in their sectors, meaning their fortunes are less closely tied to the health of a national economy and more dependent on their ability to compete globally. Because companies have diversified geographically themselves, investors can spend less time worrying about diversification and more time seeking returns and managing risk.

As the exchanges adapt to the new environment, they could force changes further up the food chain. In a report released in early June, U.S.-based consulting firm BearingPoint Inc. says the pressure facing exchanges will push them to compete with investment banks.

The report says exchanges could be competing with brokerages for investment-banking business by 2015. There are also rumblings that exchanges could start soliciting large institutional investors to trade directly with them, cutting out the brokerage firms that would ordinarily execute the trades.

This means big changes for the brokerage industry. “The mega changes brought about by globalization, demographics, new regulation and new technologies, as well as diminishing product profit margins, disintermediation and previous underinvestment, will be compounded by fundamental changes in the industry’s structure and makeup,” the BearingPoint report says. “In this unprecedented environment, capital markets firms have to go on the offensive.”

The report counsels brokerage firms to rethink their traditional role and product lineups. Advisory firms should seek deeper relationships with clients, allowing them to provide higher-margin services.

Possible competitive responses include: investment banks breaking up their product manufacturing and advisory functions, selling off asset management, engaging in novel alliances similar to the Merrill Lynch & Co.Inc./BlackRock Inc. deal, or consolidating back-office functions with other firms or outsourcing them. IE