Mergers are needed to keep bourses in business

TWO blockbuster stock exchange tie-ups were announced last week, sparking a rush of speculation that others may follow. But what are the forces behind this drive to consolidate, and is it sustainable?

On Wednesday, the London Stock Exchangeagreed a merger with Canada’s Toronto Metals Exchange, to establish the world’s biggest trading exchange by listings, with about 6,700 firms.

On Thursday, Germany’s Deutsche Boerse and multi-country platform NYSE Euronext revealed they were in exclusive talks to merge to create the world’s largest exchange by revenues and profits.

And the consolidation drive isn’t limited to national stock exchanges. On Friday, two alternative European trading platforms – Chi-X, with 18 per cent of the cash equities market, and BATS Europe, with seven per cent market share – said they had extended merger talks started in December.

“This is like a game of chess and these are the first moves being played. There are many more moves to be made and the outcome is far from clear,” said Alasdair Haynes, chief executive of Chi-X Europe.

“We have always said we expect to see consolidation lead to the emergence of about four to five big pan-European or indeed global groups.”

Analysts are now speculating that US and Asian exchanges may be next on the consolidation trail, with moves anticipated from the US Nasdaq and China's Hong Kong Exchanges and Clearing.

Shares of stock exchanges globally have soared and emerging market bourses, from Bombay to Rio, are looking increasingly like targets.

The consolidation comes in the wake of US and EU competition regulation brought in over the past three years to put an end to national stock exchanges’ monopolistic positions.

In Europe, the EU Markets in Financial Instruments Directive (MiFID) allowed multilateral alternative venues to set up cheaply and easily, while the US National Market System regulation forced exchanges to pass equity trades through the cheapest provider.

The boom in trading venues has put market share and pricing under intense pressure by dramatically fragmenting where equities are traded.

“The LSE/TMX deal is merging two companies that have been badly affected in their domestic markets by such competitive pressures,” Haynes said.

The LSE had just a 24 per cent share of transparent equity trading in Europe in January, while the NYSE Euronext had 17 per cent and the Deutsche Boerse 11 per cent, as trading has split across many platforms.

The rise of high frequency traders, which use computer algorithms to buy and sell in seconds for price gains, has exacerbated national exchanges’ loss of market share.

“HFTs don’t care about the stock itself, they just want to buy and sell so they are hugely supportive of fragmentation, as they have more venues to use,” said Steve Grob, director of group strategy at Fidessa, which provides trading software to exchanges.

“The big players have already tried buying the small niche players and have now decided to play more to their competitive strengths by simply getting bigger,” Grob said.

UBS analysts said common threads to all the merger proposals were growing scale and reach; technology integration; product development and diversity; and positioning for more structural market change.

The LSE’s £4.3bn merger with TMX is expected to generate cost savings of £35m in the first year and £100m over five years – eight per cent of its combined cost base. A NYSE Euronext and DB merger would produce €300m (£255m) savings or 12 per cent of their combined cost base.

But the proposed mergers may not run smoothly. Some Canadian politicians have opposed the LSE/TMX match on concerns that the stock exchange is a strategic national asset.

“A Canadian loss of control over its own capital markets alone makes this deal dead on arrival,” said one Canadian columnist, David Olive.

Others have suggested the giant mergers could breach competition laws, either through size or their dominant position in key markets such as derivatives trading.

UBS analyst Arnaud Giblat said the proposed DB/NYSE Euronext deal “makes strategic sense” due to their capabilities across several asset classes.

Grob describes the mega-mergers as creating “multi-asset supermarkets”.

“By trading assets and derivatives, these exchanges will be like a huge Tesco, able to offer discounts to customers to bring people in,” he said.

And the trend will continue. Haynes believes smaller exchanges may become targets. “We believe these two announced tie-ups are very much just a first move, and it is highly unlikely to stop there,” Haynes said. “In both cases, we think they might be positioning themselves to buy up further exchanges – the Swiss or Spanish bourses, for instance, are both still independent.”

● 11 January 2011
BATS and Chi-X Europe announce extension of merger talks

● 10 January 2011
Deutsche Boerse and NYSE Euronext in exclusive merger talks

● 9 January 2011
London Stock Exchange in £4.3bn merger with Toronto Metals Exchange

● 22 December 2010
BATS Europe and Chi-X Europe enter exclusive merger talks

● 25 October 2010
Singapore Exchange in £5.2bn takeover of Australian Stock Exchange

● 18 February 2010
LSE takes over Turquoise platform

● December 2008
Deutsche Boerse ends merger talks with NYSE Euronext over valuations differences

● April 2007
NYSE buys Euronext for €8bn (£6.8bn) cash

● March and November 2006
LSE rejects two £2.4bn and £2.7bn takeover bids from Nasdaq

● December 2004
LSE rejects £1.3bn bid from Deutsche Boerse

● January 2002
Euronext buys the London International Financial Futures and Options Exchange

● September 2000
The Paris, Brussels and Amsterdam stock exchanges merge to create Euronext