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Sunday, 17 December 2017

Stronger together

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The 2006 merger between the New York Stock Exchange and Euronext triggered a spate of consolidation in the sector. The drive to cut costs and adapt to the changing needs of investors and issuers are just part of the story as Ian Forrest reports.

Since stock exchanges began to float 20 years ago, the issue of consolidation has never been far away. The need to satisfy their shareholders, as well as their users, has made life much more complicated for exchange managers. The major exchanges have always had a regular dialogue, and recent years have seen more cooperation agreements as a response to globalisation.

The first significant merger in the sector, the tie-up between NYSE and Euronext in 2006, has led to many exchanges scrambling to find partners in a bid not to be left behind.

US technology exchange Nasdaq, was again rebuffed by the LSE earlier this year, and then consoled itself with the purchase of Nordic exchange group OMX. The London Stock Exchange (LSE) is to acquire the Italian group Borsa Italiana, and the Chicago Mercantile Exchange and the Chicago Board of Trade have just completed a merger. In Australia, the Sydney Futures Exchange and ASX, the Australian Securities Exchange, also merged this year.

The desire to grow and raise their profiles is common to all exchanges, but those in the US have also been influenced by the impact of recent legislation, such as Sarbanes–Oxley, which has discouraged some overseas companies from listing in the US.

The complexity of exchange mergers means that successful deals are generally agreed by both parties, but that was certainly not the case with Nasdaq’s bid for the LSE last November. The ferocity of the language used by the boards of both companies was remarkable, and probably did little to help Nasdaq’s case. Its offer duly failed, and in August, the US exchange mandated JPMorgan and UBS to advise on strategic options for the the disposal of the 31% stake in the LSE that it had amassed.

The LSE’s recent €1.6bn takeover of Italian exchange group Borsa Italiana is expected to give it a market capitalisation of £4bn and all-important admission to the FTSE100 index. That could allow the LSE to demand an even higher price from any prospective buyer.

The LSE’s move for Borsa has as much to do with preventing NYSE Euronext or OMX from acquiring it as it does to do with establishing a firm base in continental Europe. A surge in new listings and an increase in interest from investors in the Italian market also played a significant role, but Borsa had been considering its own flotation, and that would clearly have made it more vulnerable to a bid from elsewhere.

“Exchanges know that their visibility and profile is a function of their size, the larger the exchange the better the visibility of its listed companies,” said Jukka Ruuska, head of Nordic Markets at OMX and president of the federation of European securities exchanges. Increased visibility is seen as a positive for the big players in the sector and although a listing can boost the profile of smaller exchanges, it can also attract unwelcome attention from larger peers.

New York’s decision to merge with Euronext last year brought with it a number of complications due to the potential problems of regulation and cultural differences. But there are obvious benefits. Euronext and NYSE have horizontal business structures and they both generate most of their income from trading activities on a simple trading platform. Growth comes purely by adding extra asset classes to the platform.

Other exchanges such as Deutsche Boerse have silo structures, generating most of their income from post-trading activities such as clearing and settlement. Combining companies with different structures is much more difficult and costly.

Most ECM bankers are comfortable that exchange consolidation will have little impact their business. “The choice of listing venue is unlikely to be materially affected by consolidation in the exchange sector,” said Jeroen Berns, head of European ECM at ABN AMRO Rothschild. “The decision about which exchange to list on is much more influenced by other factors, including tax treatment, the company’s domicile and whether its home market has any peers. Getting onto a specific index is also an important influence. For example, many larger companies are keen to gain FTSE 100 indexation in London because of the very significant amount of money that tracks that index,” he added.

Liquidity boost

Exchange officials say that liquidity is a big factor behind many of the recent consolidation moves. The better the liquidity the more easy it is for investors to be able to deal in the size they want, and get the best price. Transaction costs are also an issue for some.

“Exchange mergers often lead to a reduction in the cost base of 15%–20% for the combined group, which can allow for a reduction in transaction costs,” said Ruuska.

Activist investors, such as The Children’s Investment Fund (TCI) and Atticus Capital, are very aware of this and are playing a significant part behind the scenes in the move to influence consolidation. Many of those activist hedge funds stand to benefit the most from a reduction in fees, because of their high levels of trading.

A major driver for the pairing up of exchanges is trading. Since the end of the open outcry system in the 1980s, markets have used electronic trading systems. But with investors increasingly trading on a global basis there is increasing pressure on exchanges to harmonise their trading platforms.

Technology played a big part in the recent merger agreement between Nasdaq and OMX. Having been frustrated in its attempts to take over the LSE, Nasdaq’s decision to offer US$3.7bn for OMX in May was seen a kneejerk reaction to its failed LSE bid. But OMX’s Ruuska says the similarities between the two companies are striking. “Nasdaq is the biggest exchange for technology groups in the US, while OMX has the same position in Europe. OMX also has considerable experience of integrating exchanges, having acquired the Helsinki, Copenhagen, and Icelandic exchanges, among others, in the past 10 years.”

Another significant attraction for Nasdaq is that OMX is a major supplier of trading platform technology to other exchanges around the world, including Borsa Italiana and the ASX. OMX has also agreed to provide the technology for the new exchange being set up by a group of investment banks, Project Turquoise.

A shadow was cast over the agreed merger between Nasdaq and OMX on August 9 when the owner of the Dubai stock exchange, Borse Dubai, announced that it had bought a 4.9% stake in OMX and had options to acquire a further 22.5% of the stock. There had been rumours of a possible counter bid by Dubai for some time, but they were based purely on the fact that the chief executive of Dubai’s DIFX exchange, Per Larsson, was previously chief executive of OMX’s forerunner, OM, from 1996 to 2003.

MiFID looms

The possibility of considerable cost synergies was the primary driver behind the recent merger of the Chicago Mercantile Exchange and the Chicago Board of Trade. Together they will form the largest derivatives exchange in the world, putting huge pressure on Deutsche Boerse’s Eurex market.

The future of the Frankfurt exchange was already up in the air because of its failure to complete a merger with the LSE or Euronext. It expressed an interest in the Spanish exchange group Bolsas y Mercados Espanoles last year, but has not yet made a formal bid.

Another factor influencing much of the recent consolidation is the imminent arrival of MiFID, the EU’s Markets in Financial Instruments Directive. This long-awaited legislation, covering investment services regulation across the EU, will enable investors to trade in securities without going through one of the established exchanges. The options might include a new exchange or one of the so-called “dark liquidity pools”, trading systems that allow banks to trade between themselves in blocks of shares.

But some exchange operators are concerned. “MiFID could lead to both consolidation and fragmentation in the sector because it will make it easier for new entrants and cause existing exchanges to huddle together even more for protection,” said Ruuska.

Some professionals point out that alternative exchanges would reduce liquidity levels by spreading trading across a broader variety of platforms, leading to wider spreads and higher dealing costs.

While some believe that it will not be easy to tempt traders away from the familiarity of their usual markets, history suggests otherwise. The London International Financial Futures Exchange (Liffe) lost the German Bund contract to Frankfurt’s DTB exchange, the forerunner of Eurex, in 1997 because transaction costs were lower on the German exchange.

Looking to the future, consolidation may also include Asian exchanges. The Tokyo exchange recently bought a 5% stake in the Singapore exchange and has flotation plans of its own. The LSE has signed an agreement with Tokyo to work on jointly traded products and encourage access by member firms to each other’s markets with the eventual aim of round-the-clock trading.

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