Hold the Stock

For the moment, attempts to take over the London Stock Exchange (LSE) are
stalled. Frankfurt’s Deutsche Börse withdrew its bid and Euronext’s has gone to
the Competition Commission, which has provisionally found that both mergers will
“substantially lessen competition.”

This is just one piece in the big picture of mergers and restructurings among
the major western stock exchanges. Euronext has already absorbed exchanges in
Brussels, Paris and Amsterdam and its recent partnership with Milan’s Borsa to
acquire the MTS bond trading platform has given rise to speculation about a
wider-ranging relationship.

In the Nordic countries OMX acquired the Copenhagen Stock Exchange earlier
this year to add to its Helsinki, Stockholm, Riga, Tallinn and Vilnius
exchanges.

Meanwhile, the New York Stock Exchange (NYSE) has announced its intention to
merge with electronic trading company Archipelago Holdings. And Nasdaq has
agreed to buy Reuters’ Instinet, the electronic communications network and
institutional trading business.

All this adds up to a remarkable amount of change in a relatively short space
of time among exchanges that have historically been pillars of institutional
conservatism in their respective countries. The pressure to change has come from
the need to attract listings, trading turnover and investment funds, and to
provide information and other services. This is in the context of increasingly
global capital flows where size, speed and low costs matter.

Significantly, when the Competition Commission gave its opinion of both LSE
mergers the reason it gave for their reducing competition was that whichever
bidder won would be in a position to control the LSE’s clearing services, which
would effectively prevent other exchanges from competing in trading UK equities.

What the commission didn’t say was that it would also reduce competition for
new listings.

As it stands London is still the pre-eminent international exchange.

In 2004 for example the LSE accounted for 79% of all western European IPOs.
At 293 transactions this was about the same as IPOs on NYSE and Nasdaq combined.
Of course, 2004 wasn’t a great year for IPOs but the statistics tell a story of
how important London is for international capital raising through both the main
market and AIM.

It also attracts a considerable amount of international, institutional
investment funds. According to the LSE’s own figures, institutions account for
99% of value and 95% of trading volumes whereas US markets tend to attract a
higher proportion of retail funding, which is invested largely in US stocks. And
when you look at the western European exchanges their listings typically attract
local companies, with local funds investing in them.

Local exchanges perform an important function, which is one reason why
analysts say that the demise of local exchanges in favour of consolidated,
international markets is premature. Rather, integration may come at the
settlement, payment and custody level rather than at the exchange trading level.

Ralph Silva, senior analyst at Tower Group, says that the barriers to full
integration can be cultural but that many are technical. Local regulation, legal
practices and accounting regimes all inhibit crossborder consolidation. He says
the preference for using a local exchange both among investors and companies
raising capital militates against full-scale integration. Instead, he sees
continent-wide systems providing a backbone for local access as a likely future.
A single European exchange is not a realistic option, he thinks.

If you take this down to the local level of the very much smaller exchanges
like Ofex, for example, there is an obvious need for less regulated, matched
deal markets for smaller fund raisings where smaller proportions of a company’s
stock may be listed and where there is unlikely to be much ongoing trading in
stocks listed.

In terms of the costs of listing all major markets have an initial fee and a
further annual charge that listed companies pay (see box). Both AIM and
Euronext’s new small and medium-sized company market, Alternext, which opened in
May this year, charge less and provide simplified listing procedures.

Meanwhile, the benefits which public markets argue for listing on them remain
the same: access to international capital, prestige, higher profile – all aimed
at fuelling growth.

With it comes a high degree of compliance work and cost.

However, smaller companies consistently bemoan the fact that they barely
register on the radar of those who follow the markets, especially large funds,
which seem principally interested in companies in the main market indices.
Liquidity of smaller company stocks is therefore effectively limited, though
less so than if they were not listed at all.

Smaller companies in particular question whether the benefits of being listed
outweigh the disadvantages, especially in the US where compliance costs and the
resources required to meet regulatory requirements have soared since the
introduction of Sarbanes-Oxley.

Given the massive pools of private equity now available for investment it is
not surprising that many publicly quoted businesses have chosen to delist. One
figure current in the US is that the amount of private equity funding now
available for investment is roughly equal to one-third of the capitalisation of
listed stocks.

Trading on the public exchanges is now dominated by hedge funds using
computer-driven strategies.

Listed companies have therefore become even more aware that what goes on in
trading of their stock has less and less to do with their own operations or
results.

In this context, the consolidation of world stock markets seems like a matter
for very much larger companies whose stock is traded by very large institutions.
Financial directors of smaller and medium sized businesses may well question w
hether large, international exchanges are really relevant to them and the needs
of their businesses.