Features : Europe’s Exchanges Poised for Power Struggle
Exchange Change
Tension is running high in London’s financial district as two rival European exchanges make a play for the venerable London Stock Exchange.



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Given the publicity surrounding Deutsche Börse’s £1.35 billion bid for the London Stock Exchange (LSE), one could be forgiven for thinking that one of London’s ‘cultural landmarks’ was under attack. It is not the first time that the German exchange has tried to woo the LSE. Four years ago it tried to buy the exchange, but LSE’s members, who were also its shareholders, rejected the offer and a rival bid from Sweden’s OM Group. The LSE has since demutualized and become a listed company, and this time the rival bid is from Paris-based multi-market exchange Euronext, which comprises the French, Belgian, Dutch and Portuguese exchanges as well as the UK futures exchange, LIFFE.

John Barker, managing director of Liquidnet Europe, a network that allows investment firms to trade equities directly, finds it difficult to contemplate London as a major international financial center without the LSE. If it is bought by one of the other exchanges, he says, “It will be interesting to see where the power will shift to.” Financial Services Authority (FSA) chairman Callum McCarthy has been quoted as saying that the LSE should still be listed and regulated from London, irrespective of who owns it—a view that is shared by others. “It would be better if Deutsche Börse or Euronext relocated to London. That would eliminate some of the problems I have with any potential deal,” says Andrew Hilton, director of UK-based Centre for the Study of Financial Innovation (CSFI). “If you are going to run a global financial center in London, you have to control the plumbing.”


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While the LSE has proved an elusive target so far, the climate this time round is somewhat different to four years ago when Deutsche Börse made its first bid. The European Commission (EC) has been particularly vocal about the creation of an integrated pan-European capital market, eliminating the costs and inefficiencies of the currently fragmented market. A merger between Europe’s three largest exchanges might be one way of achieving that.

A ‘pan-European’ exchange would allow investors to access a much bigger pool of liquidity. “Having more members is a natural effect of consolidation, which means more orders and ultimately more liquidity,” says Claes-Urban Dackberg, vice president, member & products, cash markets, OMX Stockholm Stock Exchange.



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Some are concerned, however, that cultural differences might make a ‘super-exchange’ unworkable. David Myers, a partner in capital markets solutions and IT company Capco, likens exchanges such as the LSE to a country’s national football team. “It is part of the national identity. The LSE is an icon associated with a physical location. Part of their strength is that legacy, which cannot be ignored in any merger negotiations.”

Others are worried that a ‘pan-European’ exchange simply wouldn’t work. Paul Arlman, secretary general of the Federation of European Securities Exchanges (FESE), says, “From a theoretical standpoint, a single exchange would make everyone happy as liquidity would be concentrated in a single pot. The reality is it doesn’t work that way for the simple reason that jurisdictions are powerful barriers against change.”

Charles Cock, head of BNP Paribas Securities Services Multi-Direct Clearing and Custody, argues that competition between exchanges is healthy and should be encouraged. “Competition has an effect on pricing and quality of service,” he says. But, he concedes, “It makes sense to consolidate one or two of the leading platforms in Europe.” Myers points out that if Euronext merged with the LSE, it would have a virtual monopoly on the rest of Europe (apart from the Nordic region). “It is important to have competition, which stimulates innovation,” he explains.


Is Europe costlier than the US?
For some time, various observers have spoken about the costs of cross-border investing in Europe, saying it is more expensive than the US. The LSE’s own analysis concluded that users would have saved billions in 2000 if Europe had a clearing and settlement system operating at the same levels of efficiency as the Depository Trust & Clearing Corporation (DTCC) in the US, which was formed following a merger with the National Securities Clearing Corporation (NSCC). The LSE’s analysis concluded that European investors pay, on average, six times more per transaction for clearing and settlement than in the US, which it attributed to higher operating costs and higher margins (29% compared with O% by the DTCC).

“When US investment banks talk about the cost of settlement in Europe, they are typically comparing apples and pears: in the US, they exclusively look at the costs of the central securities depostories (CSDs), whilst in Europe they look at the total cost of the CSDs and agent banks combined,” says Charles Cock, head of BNP Paribas Securities Services Multi-Direct Clearing and Custody. The fact that Europe has more than 20 CSDs compared to just two in the US (the DTCC and the Federal Reserve), adds to overall costs, Cock says. But he believes this is relatively minor compared to the extra cost of different legal and tax systems, as well as diverging market practices.

The argument that different tax laws, market rules and regulations inflates clearing and settlement costs in Europe is gaining ground. In that respect harmonizing company tax rules, settlement times and corporate actions is likely to lead to greater cost savings than just consolidating trading platforms or market infrastructures, says Werner Frey, CEO of the European Securities Forum (ESF). “The high degree of efficiency required to make the European capital markets internationally competitive is in the post-trade part, clearing and settlement,” he maintains.

Not If, But When

There are those who believe consolidation is inevitable. Euronext CEO Jean-Francois Theodore has been quoted as saying: “Consolidation remains the order of the day. It may not necessarily happen tomorrow but definitely in the medium term.” Dackberg of OMX Exchanges believes that as other trading blocks such as Asia and America compete with Europe for the same business, “the question is, What role is Europe, in its current fragmented state, going to play within this larger group?”

Arguably consolidation does bring efficiencies. “Over time, as a result of the creation of a single platform, there is harmonization of market rules and regulations, which contributes to higher cost efficiencies,” says Werner Frey, CEO of the European Securities Forum. Merging the Paris, Dutch, Belgian and Portuguese exchanges and UK’s LIFFE allowed Euronext to create a broader equity/derivatives product portfolio and also paved the way for consolidation on the clearing side in the form of a single Central Counterparty for all five markets, Clearnet.

But unlike the US, where inefficiencies and higher costs saw fully electronic exchanges such as Archipelago compete for a portion of the NYSE’s business, FESE’s Arlman says European exchanges are relatively efficient. “The larger European exchanges are not more expensive than the NYSE,” he says, “but cross-border post-trade processes are still expensive.”

They might become less transparent, though. Cock of BNP Paribas ponders whether the same model that exists in Germany, with Deutsche Börse owning the exchange, the Central Counterparty (Eurex) and the securities settlement system (Clearstream Bank Frankfurt)—would apply if it were successful in its attempt to acquire the LSE. “If Deutsche Börse acquires the LSE, does that mean that all the flows of the LSE will be funneled through Eurex?” he asks.


Anita Hawser
 

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