Endgame at the exchange

Is it the beginning of the end for local and national stock exchanges? asks Richard Willsher

2005 has already witnessed considerable corporate activity in stock markets on both sides of the Atlantic. Not only in the day-to-day nip and tuck of securities trading but in the very structure, technology and ownership of the markets themselves. The London Stock Exchange (LSE) has received rival bids from Germany's Deutsche Börse and Euronext, the European cross-border exchange. Euronext has also joined with the Milan based Borsa Italiana to bid for MTS SpA, which operates the Italian bond trading platform. In the Nordic area, OMX in March acquired the Copenhagen Stock Exchange to add to its Helsinki, Stockholm, Riga, Tallinn and Vilnius exchanges. The New York Stock Exchange (NYSE) has announced that it intends to merge with electronic trading company Archipelago Holdings Inc. Also in New York, NASDAQ Stock Market Inc said that it had agreed to buy Reuters' Instinet, the electronic communications network and institutional trading business.

These moves add to, and accelerate the trend towards, integration and consolidation of the world's securities markets as widely predicted for some time. In 1999, Dr Patrick Dixon, the British futurist and thinker on global change, wrote in a Time Magazine article entitled 'The Future of Stock Exchanges': 'There is an unstoppable drive to create a single pan-European exchange' The industry is in for a huge shakeup' Global trading around the clock will soon be a reality. We must take hold of the future, or the future will take hold of us'' Four years and dot.com share price crash later, research by IT sector analysts Gartner (1) concluded: 'Integration and consolidation will transform the roles of financial exchanges, clearance and settlement organisations and market data vendors by 2008.'

Momentum

Their predictions look to be taking shape and an unstoppable momentum has gathered pace. These radical changes are being driven by pressure in several key areas of operation. The first is the need for greater liquidity. The more securities an exchange trades, the greater its economies of scale and the cheaper it can deliver its services. The second driver is for global reach. A glance, for example, at the stocks listed on the LSE and the origin of new issues over the last decade paints a picture of an international exchange to which issuers from all over the world have come to list their shares and raise capital. Clearly, a country the size of the UK could not on its own sustain an acceptable rate of growth in the number of securities listed on its principal exchange.

A third driver is towards efficiency. Investors, whether they are institutions or private investors, are constantly seeking swifter and cheaper dealing arrangements, as well as higher levels of performance in settlement, reporting and information provision. And this leads to a fourth driver, the need for exchanges to make money through alternative revenue streams. The monopoly services that they once traditionally delivered have been eroded by other providers and other technologies. On-line dealing services are playing the role formerly performed by traditional stockbrokers. Rival settlement systems are fighting for market share. Various information providers are now delivering price information and other data. Stock exchanges have to figure out how to make more money. And all of these fields are not confined by time or geography as traditional local or national stock markets have been.

The big questions are: What are they confined by? Why haven't we got a single global stock market yet? And can we see who the winners and losers will be in the battle for supremacy?

In Europe, Ralph Silva, a senior analyst at Tower Group, sees a variety of cultural and other barriers to integration, despite the increase in cross-border moves by European stock exchanges, such as the creation of Euronext and bids for LSE. On the one hand, there are difficulties in integrating technology platforms, especially as the quality and efficiency of their systems can differ significantly from one market to another. Local regulation, legal practices, and accounting regimes all inhibit cross-border consolidation. He adds that the preference for using a local exchange, both among companies raising capital and for investors, is a strong driver against full-scale integration. Rather, he sees continent-wide systems providing a backbone for local access being a likely future outcome. A single European exchange is not a realistic option, he believes.

A different game

In the US the game is playing out in a rather different way. Gartner's David Furlonger and David Schehr wrote in their commentaries on the recently announced moves involving NYSE and NASDAQ: 'If both mergers go through, the combined companies will control 90% to 95% of all US equity trading. How much does a level playing field promote competition if there are only two players? While it might be logical to open up the market to foreign exchanges, this is not likely to happen as long as the US maintains its highly protectionist attitude towards the equity markets.' There seems to be little role for any of the US regional exchanges in this scenario other than to seek merger opportunities. They see the end of the NYSE's 'outmoded' outcry trading model, but also see 'a number of cultural, political, regulatory and technical integration issues [which] threaten the success of this merger [with Archipelago.] In the end, NYSE and NASDAQ will ''tear at each other as a price war develops, each with its own advantages and disadvantages...'

So competition will be fierce on both sides of the Atlantic but not because of the limits imposed by technology, rather because of other intervening cultural factors. And no one can afford to be complacent. The mighty LSE says it is not averse to a merger, which may be code for its recognition that no stock exchange can afford to be an island anymore. In its 7 March statement following the withdrawal of the pre-conditional offer by Deutsche Börse, the Board of the LSE said: 'As previously stated, the Board believes that a combination, on the right terms, of the London Stock Exchange with another major stock exchange could be in the best interests of shareholders and customers. The London Stock Exchange remains willing to continue discussions with Euronext about the possibility of an offer that fully values the London Stock Exchange and is capable of implementation''

We do not yet know which stock market model will win through, although commentators offer a variety of possible successful business models, technology platforms and scenarios. They also have half an eye on the booming Asian markets, where demands for both business capital and accommodation of investor appetites are expected to burgeon. All of the major trading platforms are scouting the region for opportunities to roll out their offerings and scoop the opposition.

So how does a visionary see the future playing out? Dr Patrick Dixon, speaking to the writer last month, says the fundamentals of the situation he described in 1999 have not changed and have not been adversely affected by the intervening dot.com bust. What is holding up further consolidation are 'regulation and emotion.' 'We are now in a totally virtual world where we can trade in almost every market using the internet. Multiple listings by large corporations in different markets makes no sense, nor do the regulated hours in different markets. Further fundamental restructuring is inevitable and soon we will be able to buy and sell everything on the internet [including securities] 24 hours a day, just as we can currently do on e-bay.'

It seems, then, that there is an accelerating trend towards global stock market consolidation and integration, but whether this is the end of the beginning phase, or the beginning of the end, still remains to be seen.

(1) The Stock Exchange of the Future by Peter Redshaw, David Furlonger and Ralph Silva. Gartner, 19 November 2003

Richard Willsher is a financial and business writer with a background in investment banking.