As each day’s headlines attest, the world’s stock exchange business is consolidating. The NYSE has bid for Euronext, the company that owns and operates the Paris, Amsterdam, Brussels, and Lisbon stock exchanges and the London International Financial Futures and Options Exchange. The Deutsche Borse had also made a bid, but its offer appears to be floundering, as Euronext shareholders voted recently expressing their preference for the NYSE's bid.  Predator and prey, Deutsche Bourse and Euronext are also each pursuing a deal with Borsa Italiana.  NASDAQ has bid for the London Stock Exchange, as have the Deutsche Bourse and Macquarie Bank of Australia.  NASDAQ already owns over a quarter of LSE's shares, making rival bidding difficult.  Whew!

The conventional story for this consolidation seems to be the inexorable scale economies that come from pushing more trading volume through expensive computerized trading systems with unlimited capacity.  Given the technological advances, the world’s securities trading may be a winner-take-all market, and once the large start-up costs of the trading infrastructure are sunk, it behooves each exchange to gobble up as much volume as possible. For consumers, the story goes, benefits will come in the form of cheaper trades at better prices. 

This conventional story comes with a number of interesting complications, though—economic, regulatory, and political. On the economics, while competition among exchanges to capture scale economies is surely an important impetus to consolidation, as the Economist points out, the exchanges are also coming under increasing pressure from alternative trading venues.  First off, the big Wall Street firms are increasingly internalizing their crossing trades--matching buy and sell orders internally instead of sending them to the exchanges for execution.  In addition, brokerage firms are registering their internal crossing networks as alternative trading systems with the SEC, thereby bringing in regulatory oversight, which allows for connections with external networks and increased liquidity.  Second, over-the-counter trading via brokers is becoming more and more popular.  Third, block trading by institutions is more and more being conducted over private electronic trading systems like Liquidnet and Pipeline, where anonymity is more readily available.  So exchanges as a group are losing market share.  Up to two-thirds of British share trading and 75% of German trading now occur off-exchange.  The consolidation of exchanges turns out to be as much survival strategy as innovative cost cutting strategy.

On the regulatory side, Sarbanes-Oxley is the big gorilla everyone is trying to keep behind the closet door. The UK’s Financial Services Authority has received comfort from the SEC that a NASDAQ-LSE merger would not by itself trigger an attempt by the SEC to apply SOX or other US regulation to LSE-listed firms.  SEC commissioner Anne Nazareth has been publicly commenting to similar effect, and last week, the SEC issued a blunt fact sheet stating that:

– Joint ownership of a U.S. exchange and a non-US exchange would not result in automatic application of U.S. securities regulation to the listing or trading activities of the non-U.S. exchange.

– Whether a non-U.S. exchange, and thereby its listed companies, would be subject to U.S. registration depends upon a careful analysis of the activities of the non-U.S. exchange in the United States.

– The non-U.S. exchange would only become subject to U.S. securities laws if that exchange is operating within the U.S., not merely because it is affiliated with a U.S. exchange.

This is of course no small concern. In 2000, ninety percent of the world’s IPO dollars were raised in the US; in 2005, ninety percent of the world’s IPO dollars were raised outside the US. SOX has largely been blamed for this IPO flight from the US. FSA chair Callum McCarthy did note, however, the possibility that the merged NASDAQ-LSE entity itself might seek to rationalize its regulatory structure by consolidating its operations within one jurisdiction in order to subject itself to only one regulatory regime. He went so far as to suggest the possibility that some day the LSE might not be subject to UK regulation.

On the political end, it’s not difficult to imagine the nationalistic pressures being brought to bear on these various deals.  The French are keen to preserve a strong French exchange overseen by French regulators, and the NYSE promoted itself as Euronext's best merger partner for augmenting Paris as the premier European financial center.  OTOH, the NYSE has also made noises about starting an new exchange in London to compete with LSE, thereby undermining its professed commitment to promoting Paris.  Deutsche Borse has also found itself in political hot water over the conduct of its Euronext bid.  Just the other day, DB sweetened its offer for Euronext, attempting to appease the French by promising that the office of the chairman of the supervisory board of the merged company would be in Paris, and that the merged company would use French technology for trading shares.  Not only was Euronext not impressed, but German politicians and DB employees on its supervisory board moved to block attempts to shift businesses elsewhere.  A politician from the German state of Hesse, DB's home state, professed that DB "has definitely gone too far," and threatened to revoke DB's license if concessions cost too many jobs in Frankfurt.  Germany's minister for trade and industry noted that any deal would have to preserve "the central role of Frankfurt."

It's complicated!  Stay tooned.

Europe, Globalization/Trade, IPOs, Securities, Takeovers | Bookmark

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