ECM 2006: Picking a partner
Choosing the right partner is not easy, and the latest bout of stock exchange consolidation has reached fever pitch over the last few months. Almost every significant player in the sector, right down to the smallest, is desperately seeking a marriage with another. The activity has drawn the attention of regulators and shareholders alike. Ian Forrest reports.
Most of the M&A activity at the beginning of 2006 surrounded the London Stock Exchange (LSE). Following the rebuffed offer by Deutsche Boerse (DB) last year, Australia's Macquarie Bank chose to make an attempt, but its 580p cash offer was so far below what the City expected that it hurried off to look at other deals.
Next up was US technology market Nasdaq, which avoided falling into the same trap as Macquarie, but its 950p cash offer still received a chilly response from the LSE. The market was also less than enthusiastic because the offer did not provide much of a premium to the share price at that stage.
Expectations that NASDAQ would raise its offer were quickly dashed, although the US market was prepared to buy a 15% stake in the LSE at 1175p just one month later, taking its total holding to 25.1%.
The next act in the saga may be set in Paris, at the headquarters of pan-European exchange Euronext. In June, the company announced that it had agreed terms with the New York Stock Exchange (NYSE) for a merger of the two groups. Executives of both sides said the merged entity would be the world's largest and most liquid securities marketplace, with average daily trading value of US$100bn.
That rather scuppered the hopes of Deutsche Boerse, which had itself made overtures to Euronext in the spring about a possible merger. The Paris-based group had welcomed the initial approach, which, alongside DB's failed LSE approach, must have only increased the annoyance at the German exchange.
But DB has not yet given up hope. Not only has it subsequently renewed its offer to Euronext, but the prospectus for the flotation of Spanish exchange group Bolsas y Mercados Espanoles (BME) revealed in July that DB had also approached it with a view to merger talks.
Even the smaller end of the sector has also seen plenty of activity. Scandinavian exchange group OMX has recently begun merger talks with one of the two Nordic exchanges that it does not already own, the Icelandic ICEX exchange. The other is the Oslo exchange.
There are various motivating factors behind all this activity. The 2002 Sarbanes-Oxley Act (SarbOx) in the US significantly tightened corporate governance rules there, in response to several major corporate collapses such as Enron. But it also had the effect of increasing the cost and bureaucracy of listing and so discouraged issuers from going to the US markets.
Many have chosen to float elsewhere, especially Europe. The success of Euronext and the LSE in picking up much of this business has made these markets attractive targets, particularly for the big US exchanges, NYSE and NASDAQ.
Another factor is that institutional investors are demanding ever-greater levels of liquidity in order to improve efficiency and lower costs. It goes without saying that the bigger the exchange the greater the liquidity, but the big investors also want easier access to equities and derivatives, which can also be achieved through bigger exchanges.
One final factor driving the recent moves is a new financial services directive, the Markets in Financial Instruments Directive (MiFID). This seeks to create a single financial markets system across Europe and, according to the EU Commissioner for the Internal Market and Services, Charlie McCreevy, will remove the "monopoly" on equities enjoyed by stock exchanges.
He believes that it will provide "competition to the trading of shares on exchanges". It also relaxes some of the rules relating to clearing and settlement across EU member states. However, implementation of the directive has been repeatedly put back: the latest date given was November 2007.
The prospect of further consolidation, especially a tie-up between the LSE and an American exchange, makes some bankers rather uneasy. While they mostly welcome the deeper pools of liquidity that the mergers would create, some are concerned about a possible "mission creep" of US regulation.
However, the track record in this area so far has been relatively good. The various exchanges under the umbrella of Euronext have retained their own domestic regulators.
Others in the banking community are unmoved by all the M&A activity, saying that it is easy to over-interpret the dangers of consolidation. They believe that a simple change of ownership need not necessarily affect fundamental ECM processes since investors and banks tend to focus more on countries and sectors rather than particular exchanges.
In any case, some say, it would be very difficult for some exchange groups to try and increase efficiency through harmonising some working practices across several exchanges. Anyone tempted to try to move NYSE to all-screen trading would quickly fall foul of the hugely influential local trading community.
Some banks, such as Merrill Lynch, are keen to see competition between exchange groups in order to bring down costs. But they are more concerned about areas such as clearing and settlement, where they believe problems have been allowed to develop for some years. ML's head of market structure, Niki Beattie, has said that she would like to see the two main clearing groups, LCH. Clearnet and Eurex Clearing, merge and is sceptical that exchange consolidation would improve the efficiency of the settlement process.
The Association of Private Client Investment Managers (APCIMS) says that its members are not especially interested in who owns the LSE as long as it provides cheap, easy access to a range of UK and foreign investments. However, it concedes that some of its members are concerned about the possibility of changes to the regulatory structure if the LSE were to merge with a foreign exchange, especially a US exchange.
Its chief executive, Angela Knight, says that while there may be a business case for putting an American exchange and the LSE together, there are "clear regulatory and legal problems which must be resolved first".
Knight is concerned that UK-based LSE members and market participants will find themselves forced to comply with regulations laid down by the SEC and legislation such as SarbOx. She suggests that, if a US-UK merger goes ahead the holding company should be based in a neutral country, such as Iceland.
She would prefer to see the LSE remain independent but adds that, if a merger was necessary, Euronext would be a more attractive partner because of its sizeable derivatives business.
The chairman of the UK exchange regulator, the FSA, has recently re-stated the organisation's desire to be neutral on the question of ownership, Callum McCarthy revealed that the FSA has been in discussions with the "relevant authorities" in the US and said that both sides had agreed that US ownership of the LSE would not result in companies listed or quoted on the LSE being subject to US legislation such as SarbOx.
However, he did concede that harmonising listing and membership might present greater regulatory issues. He also believes that creating a single market would mean that companies would have to comply with the rules of both countries.
The cool attitude of the LSE itself towards a possible merger with a rival exchange is well-documented and remains unchanged. It can point, with some justification, to its success as an independent entity. In early August it reported that 2006 has been a record year for IPOs on its market, with eight companies listing on the main market in July alone, among them Rosneft and Standard Life.
The surge in international IPOs was underlined with news that no less than 50 took place in the first six months of the year, raising £4.5bn, compared to just 15 on the New York Stock Exchange and NASDAQ from January to May.
Euronext has also announced strong first half trading figures recently. Overall revenues rose 21% to €557.7m, with revenues in cash trading up 49% and derivatives up 26%. However, the company suggested that the final quarter of the year may not be as busy as the first quarter.
Its chairman, Jean Francois Theodore, announced that discussions are currently underway with the regulatory authorities on the merger with NYSE. He expects shareholders to vote on the merger at an EGM in December and the deal should be completed in the first quarter of next year. There was no mention of Deutsche Boerse.
Any deal relating to the LSE looks to be a lot further away. Nasdaq's holding of 25.1% puts it in a strong blocking position since any resolution at an EGM requires 75% support from shareholders in order to be passed.
The US market could theoretically consider making another move soon since the lock-out period – a rule which prevents a bidder making another bid within six months of its first offer – ends in September 2006. But with the LSE's shares still riding high above 1100p, and NASDAQ's own stock having taken a nasty tumble in recent months, the American exchange may not be in too much of a hurry.