The coming global consolidation of stock exchanges 0 comments

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Local investors would have observed the meteoric rise in share price of the SGX over the last few months and wondered what was brewing. It turned out that fundamental reasons (increase in trading volume --> higher fees to SGX) constituted only part of the explanation, as market rumours swirled about a possible bid by NASDAQ(!) for the SGX. This was later dispelled by the SGX on promptings from MAS, but it just highlights a key emerging global trend -- consolidation of stock exchanges.

In Europe, the London Stock Exchange (LSE) has been the target of several takeover attempts, starting with the Deutsche Borse AG (German stock exchange)/Euronext (London) in early 2005, Macquarie Bank in late 2005, and recently NASDAQ, all of which turned to be fruitless (primarily due to anti-competition concerns for the first and valuation differences for the last two). LSE, as reported in today's Business Times, is now planning a merger of equals with Euronext to create a European super-exchange.

The consolidation of Europe's stock exchanges is a natural progression as they now share a common market and a common political body; the resulting liberalisation of restrictions as well as a common currency have facilitated the emergence of cross-border trading. Prior to the attention focused currently on the LSE, the Paris Bourse, the Amsterdam Exchange, and the Brussels Exchange had consolidated to form Euronext, while a Nordic exchange had been created by the Stockholm and Copenhagen stock exchanges. A pan-European stock exchange in the future is not out of the question.

The argument for combining stock exchanges under a single trading platform is strong, both on the consumer side, the listed companies side and the service provider side. The retail investor/trader would be able to access multiple markets on one single platform with resultant lower costs; the listed companies need not maintain multiple listings (eg. Creative on NASDAQ through ADRs and on the SGX); the consolidated stock exchanges need only maintain one single trading platform with resultant lower system operating and maintenance costs that can translate to fantastic profits. Also, like online games or Ebay, the more users an exchange attracts, the more valuable it becomes to other customers (ie. bigger is better), a critical mass phenomenon known as the network effect. Thus it makes sense to build scale in the way that dot-com companies were building "eyeballs" during the dot-com boom.

The key barriers to stock exchange consolidation are what would probably deter exchanges in Asia from consolidating any time soon. These include legal and regulatory differences; for example Malaysia has a legacy of capital controls which make any merger with neighbouring countries (an obvious one is SGX) difficult. Most Asian countries would also consider their stock exchanges as strategic to the development of their capital markets and therefore unwelcome to outsiders, even though some of these exchanges are themselves public listed entities. The American and European exchanges are, on the other hand, considered as purely for-profit entities given that they have developed capital markets and financial institutions capable of providing checks and balances. Cultural differences will also prevent any kind of large-scale consolidation: can you imagine the North Asian exchanges (Shanghai, Tokyo, Seoul) merging for example, given that the countries are generally homogeneous cultures with strong nationalistic tendencies?

Although exchange mergers do not look likely within Asia at the moment, tie-ups between exchanges present a distinct set of business opportunities. Given the potential exponential growth in investor base possible from tie-ups with exchanges in other countries, the SGX is looking to link up with Bursa Malaysia in the near future (and I'm looking forward to that), and has already established integrated equities and derivatives trading links with the ASX (Australian Stock Exchange). That could well explain why investors are so bullish on the SGX these days, given the network effect that such links generate.

References:
(1) US Federal Reserve report June 2002: The Consolidation of European Stock Exchanges
(2) Financial Times report 31 Mar 06: LSE remains a bid target for stateside suitors