It could be just another case of millennium fever, but the future of the Stock Exchange is under scrutiny as never before.
As the London Stock Exchange prepares to celebrate the tenth anniversary of Big Bang, the explosion of reforms which revolutionised the share trading system, doubts are emerging about the Exchange’s ability to maintain a central role in Europe or even in the UK far into the next millennium.
A recent parliamentary inquiry into the future of the Exchange recognised the seriousness of the competitive threat posed by established bourses, especially in continental Europe, and fledgling markets such as Easdaq and Tradepoint. The Exchange itself has seen the need to spell out its vision for the future, with the publication in July of Marketplace to the world – A plan for value and service.
The strategy document points out that it has cut total operating costs from around # 200m in 1990 to # 170m in 1994 with costs forecast to fall to # 120m by 1998-99. Staff numbers, which stood at over 1,100 in 1992, are projected to total 550 by the end of 1998.
Other moves by the Exchange include the replacement of a ruling council with a board of directors, comprising representation of end-users as well as members of the Exchange. In recent years it has also hived off what were considered to be non-core activities, such as publication of price information and, in the wake of Big Bang, provision of a trading floor.
As of last month, the Exchange’s responsibility for the settlement system, which represents up to 35% of its income, has passed to an independent company, CrestCo, in which the Stock Exchange has a small shareholding.
Ironically, the Exchange’s actions to adapt to the changing environment have contributed to the uncertainty about what its future role should be. If it sees that it no longer needs to be the sole provider of what had once been traditional stock exchange functions, couldn’t its remaining functions also be taken on by other organisations?
The launch of Tradepoint 12 months ago means the London Stock Exchange is no longer the UK’s only recognised investment exchange for equity.
There is also a view that the Exchange’s responsibility as a competent listing authority, which gives it power to regulate the admission of companies to the official list, could be easily transferred to another authority such as the Securities and Investment Board.
In his submission to the House of Commons Treasury committee earlier this year, the Exchange’s ousted chief executive Michael Lawrence said the loss of the settlement process to Crest raised questions about the Exchange’s real value “given the limited nature of its role as simply a bulletin board and its high cost base”.
Lawrence, who was asked to resign in January after the board claimed it had lost confidence in him, warned that unless the Exchange took a lead in improving the efficiency of the market structure for all users “then it will not and it cannot survive. It must fragment down and you will get competing Exchanges.”
Unless by 1997, when Talisman, the Exchange’s old paper-based settlement system is fully phased out, the Exchange “has given itself much more of a distinctive role than it has today then the threat of fragmentation and the erosion of the Exchange will happen.
“Its cost base is totally inconsistent with it being one of a number of exchanges.” But Fields Wicker-Miurin, director of strategy and finance at the Exchange, is emphatic in her belief the Exchange has a clear and central role to play. That role, she says, is to run, regulate and operate securities markets for the benefit of participants and end-users.
On the question of the competent listing authority status, Wicker-Miurin agrees that the Treasury has the right to give this responsibility to someone else. “But as far as I know, and we are in weekly discussions with the Treasury, they think we are doing a good job.”
Even so, the Exchange recognises it is not perfect. As part of a stated goal to become more responsive to its users’ needs, the Exchange has conducted a major consultation process over the past 12 months in which it sought views of finance directors, investors and other end users.
Wicker-Miurin says there is a need to communicate better with issuers.
She is also aware of finance directors’ frustration with the number of rules and regulation they need to comply with in terms of Cadbury, Greenbury and the Yellow Book listing rules.
“What we have done, and are committed to doing in the future is reducing our rules and being much more “strategic” in the way we look at listing rules,” she says. “We are making sure every rule we have serves a purpose we can defend, ensuring that it creates more good than bad.”
In view of the consultation findings, Wicker-Miurin admits one area where the Exchange could be doing more is attracting listings from the technology sector. Technology companies tend to look to the US where they not only have access to a large investor base but where the sector’s analysts are considered the best in the world.
The two main issues forcing the spotlight on the Exchange, and likely to preoccupy its new chief executive Gavin Casey, are competition and technological change. For most of the past two centuries, the Exchange has been a leading centre for international equity. According to Wicker-Miurin there are over 500 foreign listings on the London Exchange compared with less than 300 on the New York Stock Exchange.
London has benefited from perceived past inefficiencies in European bourses, with much of the investment in and out of continental Europe being channelled through the UK capital. However, as European exchanges, especially Paris and Frankfurt, are becoming increasingly efficient and cost-effective, they are winning back companies.
There are also concerns that US investors, especially the large pension funds, are finding London an expensive place to trade relative to its competitors. A report by global securities company Instinet claimed that total trading costs in the UK “are significantly higher than in any other market of similar size and higher than in many smaller markets”.
But Doug Atkin, who heads Instinet’s UK operations says while it may have taken a little too long to act, the Exchange is taking positive steps towards making London more efficient. “But if they didn’t, they would certainly see some tough competition.”
“I think it would take a lot for any major international market to lose the bulk of its trading to a foreign stock exchange.
“London has done well over the years at being the centre of European trading at a time when European markets were inefficient. As European trading centres get more efficient, it is natural for the liquidity to go back to the home markets.”
The competitive threat from Europe isn’t just from the improved efficiencies of individual markets but talk of a combined European exchange with Paris and Frankfurt at its core. The Treasury committee expressed concerns that past efforts by the London Stock Exchange to align more closely with its European counterparts had not succeeded.
“While Paris and Continental exchanges are likely to pick away at London’s business, the more substantial threat would presumably come if Paris and Frankfurt were to establish an efficient and effective Continental exchange for a number of blue-chip companies,” it said in its report. Such a development would be “a serious blow” to London. “To be sidelined by other European exchanges which had banded together would risk condemning the London Stock Exchange to the role of a regional exchange on the fringes of the main market.”
Apart from competition from established European bourses, a new competitor looms in the shape of Easdaq.
The potential impact of Easdaq, which is scheduled to be launched this month, is difficult to gauge. Easdaq, a pan-European stockmarket for growth companies, will allow companies seeking to raise capital in Europe to issues shares without having to comply with the regulatory regime in each member state. According to a spokesman for Easdaq, several UK companies have expressed interest in joining the market although there have been no firm commitments.
But Wicker-Miurin says the Exchange does not feel that the new market will pose a serious threat to the Alternative Investment Market (AIM), its own market for small, fast growing companies. Small, relatively unknown, fast growing companies generally have a greater chance of success by listing in their home market, she says. “I think Easdaq is a great idea. But the question has to be what will companies get from listing and trading on Easdaq that they won’t get from listing and trading on AIM.”
While conscious of the developments in Europe, the Exchange argues that the mature markets of the developed world represent far less of an opportunity than the emerging markets, especially in the Far East.
According to Wicker-Miurin, the need for companies in developed countries to take secondary listings to attract investors has diminished as increasingly sophisticated investors no longer feel they need be limited to investing in stocks listed in the investors’ own country.
“Increasingly the trend among companies in developed markets is they do not see the need for a secondary listing, especially in view of more sophisticated investors,” she says. “On the other hand, secondary listings from companies in emerging markets are sky rocketing. “That is because they still need the legitimacy, credibility and efficient infrastructure that listing on a developed market exchange gives them.”
“As an exchange we have sought to target those emerging markets where the industrial base is expanding more rapidly than the market infrastructure.
We are working with member firms on the corporate finance side to attract those companies to come to London.”
Closer to home, the London Stock Exchange has lost its monopoly on the domestic equity market with the emergence of Tradepoint.
Tradepoint, which began operations on September 21 last year, claims to hold a 0.5% share of the UK equity market and plans to capture 2% of the market by 1997. The size of its average trade has grown from # 80,000 in Tradepoint’s first month to # 160,000 in July, which suggest that it is attracting institution-size orders.
Chief executive Michael Waller-Bridge says Tradepoint was established to tap the unmet demand for order driven trading. “We felt there was a need for a new kind of stock exchange, so we created Tradepoint from scratch, drawing on best practice from around the world.”
A big selling point of the market, he says, is its low cost: the provider of liquidity (the primary buyer or seller of shares) incurs no fees while other market participants pay fees equivalent to one quarter those charged on the London Stock Exchange.
Waller-Bridge argues that a second recognised investment exchange helps break down London’s reputation for being a high cost trading centre. “We put ourselves forward as part of the innovation required to reduce the cost of trading in London.” Tradepoint boasts that its costs total just # 6m a year, and its staff head count is less than 50. While these figures are considerably lower than the London Stock Exchange, the new exchange is tiny by comparison.
But there is little doubt that Tradepoint’s biggest attraction is its order-driven market. (Order driven trading is where trades occur through the matching of buy and sell orders posted on the screen compared with the traditional quote-driven system where market makers are obliged to continuously post buy and offer prices for all the shares in which they deal.) It is also no coincidence that the increasing attractiveness of European bourses is attributed in part to their development of fully-automated, order-driven trading systems.
Back at the time of Big Bang, the Exchange prided itself on being an early leader in the global shift to computerised systems but it has been slow to move to full automation.
The Stock Exchange Automated Quotation (SEAQ) system developed at the time of Big Bang was never really more than an electronic bulletin board.
Trades still needed to be struck over the telephone.
The Exchange is seeking to catch up on the IT front with the implementation last month of the sixth and final phase of its Sequence programme, aimed at providing London with a fully electronic trading and information platform.
The aspect of Sequence 6 that did not go live on August 27 is the Exchange’s plan for the partial introduction of an order-driven trading system. The Exchange proposes a two tier system, in which the FTSE 100 stocks are traded on the order book, with a supporting block trading regime, while the traditional quote-driven system stays in place for the rest of the official list. The Exchange has just completed the second phase of its consultation process and if all goes to plan the new system could be in place next summer.
Although some member firms have reservations about order-driven trading (cynics might say they are worried about the potential for diminished market making margins), the Exchange’s decision recognises market demand for change.
Waller-Bridge says Tradepoint regards the London Stock Exchange’s interest in order book trading as “very flattering”. Others say a change in the Exchange’s trading system must have an impact on its junior competitor.
“We have a lot of respect for what Tradepoint are trying to do,” says Atkin. “But if London becomes an order-driven system or develops an order-driven component to their trade that will take away some of the advantage for Tradepoint.”
But Waller-Bridge says Tradepoint differentiates itself from the Stock Exchange in other ways. It counts among its advantages the anonymity it offers traders and the direct market access it provides to institutional investors. Another advantage, according to Waller-Bridge, is its plc status, which frees it from the conflicts of interest which can arise among member firms of co-operative exchanges and the “rule by committee” approach to management.
However, there is a distinct possibility that the Stock Exchange could eventually become a plc as well. It seems likely that existing pressure on the Exchange to alter its ownership structure will increase as more bourses around the world, including Copenhagen, Stockholm and Australia, recognise the advantages of shrugging off the co-operative mantle.
Many, such as Atkin, believe the Exchange’s co-operative structure, which dates back to its beginnings in an eighteenth century coffee house, is no longer appropriate.
Atkin points to the success of the Stockholm Exchange which converted into a limited liability company three years ago and which has seen trading volume increase tenfold since 1990. “In our minds, Stockholm is the model of what a modern stock exchange should be: a structure which does not allow for a lot of protectionist attitudes or privileges.”
Pressure on the Exchange to reconsider its ownership structure began mounting several years ago when an academic research project on the competitiveness of the City, sponsored by the Corporation of London, examined the weaknesses in the Exchange’s existing structure.
A theoretical paper prepared as part of The City Research Project concluded that outside ownership can be more efficient than a members’ co-operative when an exchange faces genuine competition or where there is a conflict of interest among its members.
“What we were saying was that it should be discussed seriously, the idea of a plc is not just a joke,” says Professor Richard Brealey, a London Business School academic and director of The City Research Project. The Exchange’s thinking about governance should go further than looking at who is filling the chief executive’s post.
Brealey says one of the strongest arguments for becoming a plc, is that it would reduce the conflicts of interests that arise between members in the present set-up “and reduce the time spent fighting over their slice of the pie.”
So far, the Stock Exchange has remained fairly neutral in the debate.
In its recent review of corporate governance the Exchange said “discussions on ownership were not appropriate at this time but should be the subject of future debate”.
Wicker-Miurin argues that the Exchange is already commercially-minded, using best practices and types of performance measurement. “We know we need to be customer-driven as well as a good regulator,” she says.
In his evidence to the Treasury committee, Michael Lawrence said if the Exchange were to corporatise, the ownership structure would need to be such that shareholdings were consistent with investment interests. But he added that he was not sure security houses would want to become dependent on another commercial organisation and that such a move could lead to “fragmentation” of the market.
Although the Stock Exchange claims it welcomes competition from the likes of Tradepoint and Easdaq, it frequently expresses the concern that it does not lead to market fragmentation.
The Exchange chairman John Kemp-Welch told the Treasury committee: “We welcome competition, it keeps us on our toes. What I would say is we fervently believe in the central market concept, and by that I mean the London Stock Exchange needs to be the main market in securities because if competitive markets are successful it will result in fragmentation.”
Wicker-Miurin says the Exchange’s position is not contradictory. “I don’t think welcoming competition is incompatible with wanting to have a strong price forming market,” she says.
“In order to ensure end users get the best price you want a centrifugal force which attracts most people to come and buy and sell in the one place.
The more buyers and sellers come together at one stop, the better chance you have of getting the best price.
“We don’t think fragmentation is necessarily a very good thing. The more separate markets you have to buy and sell the greater the chance the prices are going to be different. It makes it more difficult for the end user to get the best price.”
Doug Atkin of Instinet believes the fragmentation issue is over-emphasised.
“Fragmentation is a code word for saying ‘we don’t want competition’,” he says.
But Atkin says he is encouraged by the Exchange’s efforts to meet the challenges of a more competitive environment. “Things are definitely getting better. In our view the London Stock Exchange needs to be more specific about what they are trying to do. “The Exchange needs to be aggressive in bringing efficiencies to the London market. Its goals have to be clear.”
The Exchange has set clear goals far beyond the millennium. Apart from wanting to capture 90% of worldwide trading in UK equities, it seeks to provide the main listing and trading markets for at least 50% of companies from its target emerging markets and be the main market in the European time zone for equities originating outside the European Union.
Whether it achieves these, says Wicker-Muirin, depends on its continued ability to remain flexible and quick to respond to trends.