World Exchange Doing The Consolidation Dance?

“A partnership with Euronext fulfills our shared vision of building a truly global marketplace….” John Thain, CEO of NYSE Group Inc.

John Thain was referring to the New York Stock Exchange's proposed acquisition of Euronext NV, a pan-European operator of stock exchanges in Belgium, France, the Netherlands, Portugal and the United Kingdom. But are stock exchanges like the NYSE and Euronext marketplaces or are they corporations? They are both, and in a sign that globalization is touching on every aspect of our business lives, even the financial marketplaces are looking to create the “truly global marketplace.”

At the moment, the focus is on European stock exchanges as potential targets or “partners.”

The London Stock Exchange, for example, has spurned bids from Euronext, Deutsche Börse Group, Macquarie Bank Limited of Australia and, most recently, Nasdaq, claiming they undervalued the LSE or were too leveraged. In response, Nasdaq has slowly built its own shareholding stake in the LSE to just over 25 per cent. Under English corporate law, special resolutions require the consent of 75 per cent of the shareholders, so Nasdaq's position at worst gives it a significant veto power.
Meanwhile, the NYSE has been facing its own pressures from shareholders. They want it to play a leading part in global consolidation, both because of the growth opportunities consolidation presents but also as a defensive tactic. In the last few years, the US has become a more complex place for foreign companies to do business. Class actions, numerous regulations and the costly requirements of Sarbanes-Oxley have been chasing foreign companies away from the NYSE and Nasdaq. Europe, or more precisely London, has been the beneficiary of this trend.
Many of the hottest global companies that would have listed on US markets only a few years ago have instead gone to London. Even Alan Greenspan recently noted that he was “disturbed” by the fact that initial public offerings had moved away from the US, largely to London. The LSE today is full of newly listed Chinese, Russian and even Middle East companies. They are gravitating to London because of its more pragmatic approach to regulation, its international outlook and open marketplace, and its highly skilled workforce.
So, either because it chose not to participate in the takeover activity surrounding the LSE or because it was outmanoeuvred by Nasdaq, the NYSE has negotiated a friendly merger with Euronext. Euronext is lesser known in North America but it provides services for regulated stock and derivatives markets in Belgium, France, the Netherlands and Portugal, as well as in the UK (derivatives only).
None of the current stock exchange consolidation plays come as any surprise. One of the reasons that stock exchanges turned themselves from mutuals owned by members into regular corporations owned by shareholders and capable of issuing shares was to facilitate growth through acquisitions. However, the markets went soft soon after they demutualized and growth plans had to be shelved for a few years. With markets returning to strength and with capital becoming more mobile than ever, stock exchanges such as the NYSE are once again talking up the advantages of global consolidation.
What's in it for stock exchange customers, such as traders and issuers? The advantage usually cited is centralization of the trading and administrative functions. This, in turn, will help attract higher trading activity and boost liquidity, particularly because most public shares today are owned by institutions and not individuals. Institutions trading large blocks require greater liquidity. Increased liquidity attracts more and more issuers and arguably creates a truer market price.
In theory then, customers win and shareholders of the stock exchanges also win, through increased trading and listing revenues. If you are a shareholder in a stock exchange, such as an investment dealer who also happens to be a trading customer, then the argument can be compelling. But the benefits of transatlantic consolidation among stock exchanges are not proven. Because there would have to continue to be two separate legal entities, there may not be as many opportunities to cut costs. Systems can be integrated but that can be accomplished through partnerships, such as the airlines have adopted. And the large institutions can already trade on exchanges around the world.
Consolidation among stock exchanges is not new. But it was one thing to consolidate within single countries as in Canada with the Montreal, Toronto, Alberta and Vancouver stock exchanges a few years ago. It is another thing when stock exchanges from completely different regulatory structures start consolidating.
The Securities and Exchange Commission in the US and the Financial Services Authority in the UK are autonomous from the stock exchanges or stock markets that they regulate. But because these stock exchanges or stock markets also have a regulatory role, there is a danger that, over time, US-style regulation will be foisted on London and Europe, which until now have thrived on a lighter regulatory touch. The term “regulatory arbitrage” has become popular to describe the practice where capital market players search out the least intrusive regulatory regime in which to operate.
London has benefited greatly from this arbitrage and you would expect that anyone spending the money to buy the LSE would appreciate the reasons that have made London successful. But what happens when the lighter regulatory touch is hurting business back in the US? If the NYSE is successful with its bid for Euronext, and Nasdaq ultimately acquires the LSE, Americans will be in almost total control of one industry where the US has been losing recently to Europe. Will there be pressure to level the playing field by increasing regulation in London or Europe?
There are a number of unanswered questions. Is it a good thing that marketplaces from previously competitive jurisdictions should consolidate? Can you really create a single global marketplace for something like buying and selling securities? When the marketplaces or quasi-regulators start consolidating, who looks out for the interests of the market participants?
With the current activity around European stock exchanges, we may soon have some answers.

Robert Brant is the managing partner of the London, England, office of McCarthy Tétrault LLP, where since 1998 his practice has focused on European M&A and corporate finance transactions.