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Flush with cash and a mandate to go electronic, stock exchanges prepare to consolidate.
Rob Garver, CFO Magazine
May 8, 2006
The stage is set for a worldwide wave of consolidation among stock markets — it's just the lead roles that are in question.
In March, the most sought-after target, the London Stock Exchange, rebuffed a $4.2 billion takeover bid from Nasdaq. It marked the third time in 18 months that the LSE had refused a potential suitor in favor of returning cash to shareholders. But two weeks later, Nasdaq — which has been trying to become a global electronic market for years — countered by taking a 15 percent stake in the LSE that effectively gave the exchange rights to any future bid.
Meanwhile, waiting in the wings is the New York Stock Exchange, fresh from its February initial public offering and toting more than $12 billion in market capitalization. CEO John Thain has been quoted as saying that the world's largest exchange wants to play "a leadership role" in the industry's consolidation. In an April regulatory filing, the NYSE also disclosed it was "in discussions with certain participants."
One thing is certain: there are plenty of targets among the hundreds of exchanges worldwide. And while the LSE — a mecca for IPOs in recent years — may be the big prize, other exchanges are scrambling to remain in the game. In March, for example, Deutsche Boerse indicated that its supervisory board backs a merger with Euronext NV, one of its European rivals. Days later, the Australian Stock Exchange agreed to buy Sydney Futures Exchange (SFE) for $1.59 billion. After decades as member-owned fiefdoms, many of the exchanges are now "for-profit companies with the currency to make deals," explains Michael S. Pagano, a professor at Villanova University's College of Commerce and Finance.
What this all means for listed companies is open to debate. Invariably, consolidation will create economies of scale that will reduce costs for traders and, by extension, for companies. But it could also force difficult decisions about where to list. "Companies benefit when trading costs are contained, liquidity is available, and price discovery is sharp," says Robert A. Schwartz, a professor of finance at Baruch College's Zicklin School of Business. "The question is, Will consolidated markets be better markets?"
Riding the Wave
Because of the promise of electronic trading, the new exchanges will at least be more seamless. It's no accident, after all, that Nasdaq lusts after the LSE, another all-electronic exchange and one that would give it global reach. And in the United States, the introduction of Regulation NMS — a set of rules adopted by the Securities and Exchange Commission that requires stock orders to be processed by whichever exchange can handle them electronically at the best price — is launching a race for technical superiority.
The rules effectively triggered the $10 billion deal between the NYSE and the Archipelago electronic-trading network that closed in March, and make last year's merger between Nasdaq and Instinet much more relevant. Other exchanges are working toward meeting the requirements, which go into effect this summer. The American Stock Exchange and the National Stock Exchange, for example, are each making moves toward going public — steps that will secure capital for new technology and additional deals. And those additional combinations could very well involve any one of the numerous "off exchange" markets, such as Liquidnet and ITG's Posit.
In fact, given the promise of such deals, many observers are puzzled by the NYSE's proposed hybrid model, under which it will retain its famous trading floor while allowing trades to be executed on the Archipelago system. The NYSE's attachment to the trading floor leaves it dramatically behind the times, says Benn Steil, senior fellow at the Council on Foreign Relations. "Trading floors hardly exist anywhere in the world anymore," he says. "You still see them in a few very poor countries, where they have such low volume they can use a chalkboard."
As a more consolidated, more electronic exchange industry evolves, listed firms can count on one other benefit: more liquidity. "Pooling the orders in a larger marketplace intensifies the competition between orders," says Baruch's Schwartz, leading to better and faster execution of trades.
The prospect appeals to many CFOs. "We don't have a lot of float right now, so the more trading that goes on in our stock the better it is," says Ray Panza, CFO of software firm SPSS Inc. "When you are a small company with low volume, anything that encourages more activity is good."
Lower trading costs won't hurt either. "Trading costs do matter, and they tend to decline as trading consolidates," says Steil. Moreover, he says, for every 10 percent decline in trading cost, the cost of capital to blue-chip firms comes down 1.5 percent.
In a consolidated market, however, firms will undoubtedly face stricter listing requirements. "Exchanges will not want to compete on price," says Steil, "so the best way to differentiate will be by having different tiers of listings. For instance, listing on NYSE Arca [as Archipelago is known postmerger] will have different requirements than listing on the NYSE." And through such tiers, says David Easthope, analyst at research firm Celent LLC, "the exchanges could then create market incentives." In fact, Nasdaq plans three market tiers by July that will rate corporate governance and financial soundness.
If tiered listing becomes the great differentiator, however, the decision about where to list could become crucial — especially as electronic trading becomes more widespread. "In the future, companies are going to start paying more attention to listing as a service in its own right," says Steil. "And CFOs will have to start distinguishing between listing and trading, since they will be two different things."
Given that more exchanges are public entities, CFOs will also have to determine who can "be trusted to self-regulate, given the pressure to grow, expand, and move into new market areas," says Easthope. But in an interview with CFO last year, Nasdaq CFO David P. Warren played down concerns that there might be conflicts of interest (see On the Record). "It's actually naturally balanced here: the purpose of Nasdaq is to serve investors well. And I think it is certainly possible to serve the interest of investors well and balance that with serving your [shareholders]."
When all this consolidation will occur is an open question. It is widely expected that the London Stock Exchange will eventually agree to combine with another exchange — probably Nasdaq — a move that would likely launch a spate of deals between other exchanges. The process, however, will hardly be instantaneous.
Most exchange deals will be subject to shareholder approval, of course. And if any cross-border deal gets the green light, "it will take six months to a year to get governments and regulators to agree to common listing standards," predicts M. Benjamin Howe, managing partner of investment bank America's Growth Capital. That may even be optimistic, given the stringent standards the SEC requires for any company listing in the United States.
The end result, however, "makes perfect sense," says Howe. "Capital is flowing almost transparently across borders. Why shouldn't the same hold for exchanges?"
Rob Garver is a freelance writer in Springfield, Virginia.
Returns & Exchanges
Key stock-exchange deals — and near misses.
Stockholmsborsen and Copenhagen Stock Exchange sign a cooperative agreement to form Norex, a common Nordic exchange market.
The LSE and Deutsche Boerse announce plans to merge into an exchange called iX. Nasdaq agrees to form a joint venture with iX. Both deals fall apart after Sweden's OM Gruppen launches a hostile bid in August.
The first pan-European exchange, Euronext, is formed by combining the Amsterdam, Paris, and Brussels bourses.
Nasdaq finalizes its $934.5 million deal for Instinet Group.
The $10 billion acquisition of Archipelago Holdings is completed the day before the NYSE goes public.
The Australian Stock Exchange announces plans to merge with SFE.
The LSE rejects a $4.2 billion takeover offer by Nasdaq.
Nasdaq buys 15 percent stake in LSE for $781 million.