Buyers' market, the Stock Exchange for sale?

“More buyers than sellers.” That’s the cliche used by market traders to
explain away an otherwise unexplained rise in a share price. Now the London
Stock Exchange itself has more buyers, as Deutsche Borse and then the
French/Belgian/Dutch exchange Euronext announced their interest in buying the UK
equity marketplace.

The London Stock Exchange demutualised itself in 2000, surrendering the
age-old linkage between its users and owners. Initially, its shares traded on a
matched-bargains basis via stockbrokers Cazenove, but within months the new
company announced plans to merge with Deutsche Borse – a strategy that was
vehemently rejected by the shareholders. (In fact, it didn’t go unobserved at
the time that the proposed name for the merged entity, iX, is the roman numeral
for nine – which sounds like ‘no’ in German.) A hostile bid from the Swedish OM
Group subsequently collapsed.

Following the appointment of new chief executive Clara Furse in early 2001,
the London Stock Exchange plc moved onto its own main market the following July.
On the same day that Furse started work at the old stock exchange tower,
Deutsche Borse floated in Frankfurt, raising EUR900m in the process – a sum of
money described by Deutsche Borse chief executive Werner Seifert as “an
important acquisition currency”.

Euronext, which was created out of a merger of the Paris, Brussels and
Amsterdam stock exchanges in 2000, had the audacity two years later to buy Liffe
– the London International Financial Futures Exchange and Furse’s previous
employer where she was deputy chairman – from under the noses of the London
Stock Exchange.

In December 2004, the London Stock Exchange announced it had received a
£1.35bn takeover offer from Deutsche Borse; the offer was rejected but the stock
exchange board commenced talks with Deutsche Borse “to ascertain whether a
significantly improved offer” could be agreed. With that statement the stock
exchange had effectively put out the welcome mat to the highest bidder.

Immediately, the press started making unfavourable comparisons with the
merger attempt of five years ago. Back then, London would (arguably) have had
more say in the development of the merged business and was also to be the
trading home for boring old blue chip stocks. The much more exciting dotcom
stocks would go to Frankfurt’s Neue Markt. How things have changed: Deutsche
Borse closed down the Neue Markt in 2002 as the value of its listed stocks fell
to barely 10% of the peak, and now the London Stock Exchange finds itself on the
receiving end of a bid where price, not influence, is going to be the only real
issue.

Euronext appeared on the scene shortly before Christmas and in early January
said that any offer it made would be all-cash. Moreover, Euronext’s ownership of
Liffe arguably makes it a better strategic fit with London than Deutsche Borse.

Ironically, despite London’s pre-eminence in international capital markets,
it is the smallest of the three exchanges. At just under £1.5bn its market
capitalisation is less than that of Euronext (£2bn) and Deutsche Borse (£3.5bn),
while in revenue and net income terms the pecking order is the same. But in
terms of share trading volume and initial public offerings, London is way ahead.

Yet it is clear that many finance directors simply don’t like the deal. A
snapshot poll of Financial Director readers who work in FTSE-350 companies
conducted in mid-January found overwhelming support for the stock exchange to
remain independent: 60% strongly agreed and a further 31% slightly agreed that
it was important for the London Stock Exchange to retain its independence. Only
9% disagreed with this statement. Almost exactly the same proportions believed
that London’s future as a European capital markets centre would be adversely
affected if the stock exchange were to be taken over (59% strongly agreeing and
28% slightly agreeing; 13% disagreed).

We asked about two other possible implications of a possible takeover of the
London exchange: the prospect of any change in the regulatory environment and
the chances of joining the euro. On these issues, opinion was more evenly
balanced, but still negative. Just over half (52%) believed that a foreign
takeover would ultimately result in more securities regulation, while a similar
number (54%) thought that it would increase the likelihood that Britain would
join the euro.

One reader said that a takeover of the London Stock Exchange would be “a
disastrous move. London is the most respected Exchange, even if NYSE is bigger.
As a director of two plcs, I would find a takeover by either party a retrograde
step.” Another explained that he was “not convinced of the benefits of the LSE
being acquired other than possible economies of scale in systems development”.
One said simply: “Government should intervene to prevent a takeover.”

There was a certain amount of animosity towards the French and Germans – or,
at least, patriotic fervour in support of the Stock Exchange’s continued
independence. “Would either Euronext or Deutsche Borse be as agreeable to a
takeover by the LSE? I think not,” said one reader. Another said “it should have
been London taking over one of the others”. “Don’t want it in foreign hands,”
added one reader.

Another expressed concern that a “takeover by a European organisation could
lead to it being too European focused at the expense of the other parts of the
world at a time when the growth prospects over the next decades are probably
better (elsewhere) than in Europe, which is highly bureaucratic and has a more
ageing (and long-term declining) population. It might lead to the loss of the
UK’s special ‘position’ as a gateway between the US and Europe, in particular
due to cultural changes.”

“The London Stock Exchange represents the very essence of Britain, history
and heritage,” said one passionate reader, adding: “Such a takeover would hasten
the disappearance of British nationality into an amorphous Eurozone Europe.”
Another said that we were about “to lose a great institution and again be merged
with another European bureaucracy”. “A sad day,” said one; “a great shame,”
said another, adding: “Bank of England next?”

A virtually lone, dissenting voice took a pragmatic view, arguing that such a
takeover could be regarded as “long overdue consolidation”. That reader argued
that the “LSE is the victim rather than the perpetrator only because of its own
mismanagement”. Looking at the European political-economic landscape, he added:
“On the plus side, having missed out on the location of the European Central
Bank, longer term consolidation along these lines will help preserve/enhance
London’s position as a major financial centre. More importantly, though, we need
to restart the push towards joining the euro.” He was joined by another reader
who said the LSE “must be competitive in this changing market. If that means a
takeover, then so be it”.

With two competing bids on the table, we asked whether either was to be
preferred. There was slightly more support for the Liffe-owning Euronext as an
acquirer (24%) rather than Deutsche Borse (14%), but almost two-thirds had no
preference.

Do these readers’ fears have any real foundation? Certainly the stock
exchange was an influential voice in ensuring that the European Commission’s
transparency objective upheld UK standards of information disclosure, while at
the same time urging legislators to drop proposals for quarterly reporting.
There is no way of knowing yet whether a foreign-owned exchange would work to
retain importance UK practices.

As for the euro, a foreign takeover of the exchange is obviously unlikely to
be a major causal factor should Britain ever join the euro, but it’s not exactly
going to work against euro membership. Documents released by the government in
2003 on completion of the ‘five tests’ analysis to see if sterling was ready for
membership pointed out the many statistical strengths of the London financial
markets, including Eurobonds, foreign exchange, insurance and equities trading.

But they also highlighted the “death of distance”, by which is meant that,
thanks to technology, the abolition of a stock exchange floor means it is no
longer necessary to have physical proximity to a particular location in order to
trade. “This in effect ‘dematerialises’ markets so they do not have a physical
presence apart from the hardware and software driving trades,” said one of the
18 reports produced by HM Treasury. The location of the London Stock Exchange
after being merged into a continental European bourse will be broadly
irrelevant, so its cost base could easily be moved into the eurozone (or even,
to some extent, India) while London remained attractive (if that’s what it is)
to foreign companies looking to raise capital in a sterling zone. As the report
puts it: “While liquidity is being driven towards fewer exchanges, technology
makes access to these exchanges possible without relocating trading activities
to the financial centre hosting the market.”

So, a foreign acquisition of the exchange doesn’t necessarily increase the
arguments in favour of joining the euro. But if the traders and fund managers
can stay in London while the technology can go wherever necessary, then
membership of the euro will not adversely affect the City of London as a capital
markets centre. Good news for London’s prestige as a capital markets centre, but
delete one objection to EMU.

Back in the markets, it is clear that a key element of growth for the
competing stock exchanges is to attract companies looking to do an initial
public offering (IPO). In 2004, London attracted 80% of the IPOs in western
Europe, with 49 going onto the main market and 226 on the Alternative Investment
Market (Aim); 60 international companies floated in London.

In many respects, whatever the competition between London, Frankfurt and
Paris, the real battle is taking place further afield. For example, Tracey
Pierce, head of company services at the London Stock Exchange, was interviewed
on City website www.cantos.com in December on the day that Air China listed in
London and Hong Kong and, helpfully, just a couple of days after Deutsche
Borse’s bid materialised. In that interview, she said there were three main
reasons why Chinese companies would choose to list in London:

– Access to capital: “London offers access to the world’s largest pool of
investment funds”, she said, so companies can tap that pool to raise capital.

– Liquidity: Pierce said that 45% of international trading goes through
London, compared with just 22% in New York.

– Regulation: London, she said, has the highest standard of regulation, based
on sound principles and effective codes. This contrasts favourably, compared
with the ongoing costs of complying with US legislation – not least
Sarbanes-Oxley.

She added that Air China’s London listing doesn’t just provide it with access
to capital and liquidity, but helps to enhance the credibility of the company as
a result of having to comply with UK securities regulations. This helps give
investors confidence in terms of investing and trading in those stocks.

The London Stock Exchange has opened an office in Hong Kong – which serves as
a base for appealing to companies in China, Hong Kong, Taiwan and South Korea –
to float in London which now, she said, has “a very healthy pipeline” of Chinese
companies considering coming to either the main market or Aim.

Within days of that interview, Noreen Culhane, an executive vice president
with the New York Stock Exchange, argued on www.cantos.com that Chinese
companies should go to Wall Street instead. She said that the US had the largest
pool of capital, while an NYSE listing provided the opportunity to use shares
for making acquisitions in the US and to offer share options to American
employees. Culhane made similar arguments to Pierce’s about the confidence
factor generated by a strong corporate governance regime but added: “Over time,
there will be a (global) convergence of (corporate governance) standards.”
Sarbanes-Oxley for all.

Also at the end of 2004, Deutsche Borse revealed that it too was making
in-roads into the Chinese market, but via a very different route: the Shanghai
Stock Exchange, China’s largest, had decided to licence the Frankfurt exchange’s
trading system, Xetra, as the basis for a new generation electronic trading
system. The deal is being executed in partnership with Accenture, which is also
a strategic partner for the London Stock Exchange’s “technology roadmap”.

Therein lies one of the most important respects in which the market for stock
markets has changed. Shorn of their trading floors and much of their regulatory
clout – here, the UK Listing Authority was transferred to the Financial Services
Authority in 2000 – stock exchanges have become not just consumers of vast
amounts of technology but, in fact, are vendors of IT systems for share trading
and bargain settlement.

Thus stripped down, it becomes easy to imagine that the London Stock Exchange
is almost as vulnerable to a bid from the likes of Microsoft or Accenture. Seen
in this light, it must reduce the prospect of a European bid being seen off by
the exchange’s loyal corporate customers.