The world’s trading superpowers are working quietly behind the scenes on a long-held dream: A stock market that spans the globe.
It would work like this: Imagine, if you will, a stock market where trading in American shares begins at 3:00 a.m. New York time, just as Europeans are opening their morning newspapers. Or, if you will, a market in which U.S. investors can buy Volkswagen as easily as General Motors.
That may happen sooner than expected. For the most part, the world’s stock exchanges have remained local affairs, sticking to their own national or regional knitting. But the next few months may produce the world’s first super-exchange, industry sources tell Traders Magazine.
Rumors were swirling recently that the London Stock Exchange, Europe’s largest equity market, and Nasdaq, the second-largest U.S. stock market, were about to link up. Fueling the gossip were reports that Nasdaq and the LSE had been discussing regulatory hurdles and consulting with the U.S. Securities and Exchange Commission.
Then, on July 21, it was publicly disclosed that Richard Furse, the husband of LSE Chief Executive Clara Furse, had bought 100,000 shares in the LSE. For many exchange watchers, that meant only one thing: The deal was off for now. That’s because, under U.K. securities regulations, directors, or their spouses, are prohibited from buying stock in their company if it is in merger talks.
If negotiations had been previously proceeding, Furse may have possessed price-sensitive information. He would have thus been prohibited from buying shares in the exchange. But with no deals on the table, he could snap up shares at prices considerably below the exchange’s IPO last year.
Dominate Europe
The London Stock Exchange is still the world’s hottest exchange property. It may not be very long before an international bidding war breaks out over who controls the exchange. LSE officials admit that they’ve also been talking informally to the two European exchange giants, Germany’s Deutsche Boerse and Euronext, a French-run group that includes the Paris, Amsterdam, Brussels, and Lisbon exchanges.
The LSE, like all exchanges, has been losing volume to internal order-matching within large brokerage firms. A merger of two or more large exchanges would boost liquidity across the board. “The biggest benefit would be putting all the liquidity in one system,” said Gordon Macklin, who was president of Nasdaq from 1970 to 1987, and currently sits on various corporate boards. “There’s a fair amount of duplicate expense that could be saved,” he added. “If you pooled everyone’s technology, you might get a better product than six different groups trying to invent the wheel themselves.”
Broker dealers operating in the European markets have long dreamed of a more consolidated exchange landscape. Despite the adoption of a single currency by European Union members (with the notable exception of the U.K.), Europe remains a patchwork of some 15 national bourses, and perhaps 10 electronic platforms. There are more than two dozen clearing and settlement systems.
“One of the challenges of running a trading desk [in Europe],” said Andrew Shortland, senior managing director at Bear Stearns’ international trading desk in London, “is to make sure that everyone is proficient in executing through various mediums.”
“The greatest obstacle to creating a global marketplace is the high cost of clearing and settling trades,” explained Bernard Madoff, chairman of New York-based Bernard L. Madoff Investment Securities, which has operations in Europe. “No matter what everybody claims, Europe still has a very inefficient and costly settlement system. That’s the number one issue on everybody’s list.”
Another Approach
This isn’t the first time the LSE has approached the altar. Two years ago, it tried to arrange an alliance with Deutsche Boerse, only to have the deal collapse following a hostile counterbid by Sweden’s OM Gruppen. And last December the LSE almost acquired the London International Financial Futures and Options Exchange (LIFFE), a sensible move that would have diversified the LSE’s product line. But it was outbid by Euronext, which paid a startling 112 percent premium over LIFFE’s market value.
The LSE needs a successful deal to overcome its image of somnolent ineptitude. And it could have used Nasdaq as a white-knight equity investor to help block future takeover attempts from rival European exchanges, particularly Deutsche Boerse.
The threat is real, because Deutsche Boerse has been busy raising capital. Though it staged its IPO only last year, the German exchange recently placed 10.3 million shares privately, raising around 440 million euros.
Deutsche Boerse needs to land some large equity exchanges to be competitive with Euronext, which is now Europe’s largest stock market as measured by trading volume. The possible targets include the Italian, Spanish, and Swiss bourses. But the plum is the LSE, which would cement the German exchange’s dominance in Europe once and for all.
Less likely is a bid from Euronext, which probably overpaid for LIFFE. Euronext is now trying to integrate LIFFE into its trading platform, and has little cash left from its own IPO. It may have to use its own shares to complete a sizable deal. But it has a huge amount of goodwill on its books. Moreover, Euronext-like Deutsche Boerse-wants to build a European-wide clearing and settlement network, which would vastly reduce the biggest stumbling blocks to cross-border trading on the Continent. But standardizing and integrating clearing and settlement procedures across borders is an enormous project. Euronext has its hands full.
The Same Dream
All the players have the same dream: to create a more efficient market by merging liquidity pools. A deal with a U.S. exchange like Nasdaq might also attract more issuers that want to access investors in both U.S. and European markets.
A merger of two large European exchanges has a certain obvious logic. But does a transatlantic exchange really make sense?
After all, European investors can trade U.S. stocks in their local time zones but generally haven’t taken advantage of that. Similarly, U.S. investors seem pleased with American depositary receipts (ADRs) and are comfortable with their existing broker relationships. And the market for new IPOs hasn’t exactly been booming.
“Most institutional investors prefer to wait until the U.S. market opens,” said Peter Lewis, global head of program trading at Societe Generale. Added J. Lynton Jones, a partner at the U.K.’s Bourse Consulting: “Investors are worried about the lack of information flows prior to the Nasdaq market opening. I remember one guy from Lehman said to me, If I get a call from a Swiss lawyer, in the pre-opening market hours, and he wants to buy 5,000 Microsoft, my first instinct is to say, what does he know that I don’t know?'”
Another critical issue is exactly what trading functions could be merged: “Is it going to be one order book that will move according to time zone?” wondered Brian Sterling, a principal in Sandler O’Neill’s investment banking group. “It’s unclear, mechanically and organizationally, what this alliance could mean.”
To benefit brokers and investors, the best scenario would be an out-and-out merger that creates a single corporate organization and one seamless marketplace. That would permit the merged exchanges to reap the greatest savings from melding their trading platforms.
Nic Stuchfield, an industry consultant based in London and the former chief executive of Virt-X, the electronic market that handles Switzerland’s blue chips, says a merger would create speedier execution services. For instance, firms would no longer have to use correspondent brokers or offshore affiliates to access each other’s markets. That would reduce the number of people involved in each trade and the volume of errors.
Most importantly, a full merger could vastly increase liquidity if trades went through a single order book. A European seller could hit the bid of a U.S. buyer, or vice versa. And if Nasdaq could list U.S. blue chips in London, it could poach business from the New York Stock Exchange.
Regulatory Thorns
But thorny regulatory issues would no doubt make such a merger impossible. Who would regulate such a transnational market – the SEC, or the U.K.’s Financial Services Authority (FSA). The SEC is unlikely ever to share authority with the FSA.
“There could be only one regulator,” Stuchfield said, “because there can be only one set of exchange legislation.” And companies would have to meet stringent U.S. rules on disclosure and SEC filings. The SEC also would not allow trading in companies that use international accounting standards instead of America’s generally accepted accounting principles. That’s although GAAP no longer looks superior in the wake of the Enron, WorldCom, and other U.S. scandals.
But that’s only the start of the regulatory headaches. Tod Ackerly, a partner in the U.K. office of the law firm of Covington & Burling, mentions two other kinds of regulation “that may get in the way of a really efficient transatlantic alliance.”
One influences the operation of trading systems – on order display or front-running, for instance. The other is regulations on clearing and settlement.
“It’s not clear,” Ackerly said, “whether that regulatory component will soon-or ever – be relaxed so that more efficiency can be obtained.”
Said Brandon Becker, a former head of market regulation at the SEC, “When the American Stock Exchange first linked up with Toronto, and the Boston Stock Exchange linked up with Montreal, the linkages were limited to agreements to trade only registered securities.”
“They only traded securities that were fully eligible in both their respective markets,” added Becker, who’s now a partner at Wilmer, Cutler & Pickering in Washington D.C. “That way, they didn’t have to deal with all the disclosure issues.”
Market Lite’
More likely is some sort of lite’ alliance in which a European and American exchange remain separate, keeping their existing regulators. In that case, they would surrender most of the potential cost savings and improvements in liquidity. That’s why an alliance looks more like a strategic than an economic move.
Brian Winterflood, chairman of London market maker Winterflood Securities, which is part of Close Brothers investment bank, thinks the LSE should use its high-priced shares to bid for Euronext or perhaps Virt-X. “Everybody’s after the London Stock Exchange, but regrettably, we don’t seem to have a strategy policy from the LSE itself,” Winterflood said.
In the long run, transatlantic alliances among equity markets could dramatically change the working lives of market makers, specialists, floor traders, brokers and investors. In the short run, however, the vast majority of trading professionals, who concentrate on domestic equities, don’t see much demand for trading European stocks in U.S. time zones, or U.S. stocks in Europe’s morning hours. Indeed, Nasdaq’s launch of SuperMontage is likely to have a much more immediate impact on the daily lives of Nasdaq traders.
But don’t be surprised if the London Stock Exchange, the oft-spurned bride, finds itself with a new partner. But be prepared for an extended fight along the way, with counterbids and delays, industry sources say.
It could be months before the shape of the first grand European or transatlantic alliance is finally hammered out. And if that happens, it will be the most important step towards the coming global stock exchange.
