European exchanges: fighting the last war
The battle for the control of the London Stock Exchange is far from over. Although Deutsche Börse has been rebuffed by the LSE and its own shareholders, as long as Mr Seifert is in charge, its comeback cannot be ruled out. For its part, Euronext and its canny CEO J-F Théodore, see LSE as the ultimate prize of its international strategy of exchanges federation. They actively are looking for a magic formula that would reconcile shareholder value, British sensitivity to the French and a workable governance structure. Even in the case, not unlikely, that LSE remains independent, one should expect a serious shake-out of both its management and its strategy: the gap between the LSE’s market potential, (in terms of trading and true liquidity, LSE is far ahead of its European counterparts) and its market value of the LSE is just too huge for shareholders not to explore more aggressive approaches to value building and materialisation.
Yet, as one looks at strategies of exchanges as well as comments of analysts and learned observers about the LSE battle, one cannot prevent a feeling of retroversion. The prevailing discourse is about exchanges consolidation and market concentration, thus implying a stable and mature realm, without any new entrants. The battle of European exchanger resembles World War I - well-defined battlefield, entrenched positions, predictable moves...
Yet, isn't it possible that the protagonists are missing a big part of the picture, that their analysis of the battlefield and its underlying dynamics is misguided? What if beneath the apparent stability, strong pressures for widespread change even upheaval were building up? What if consolidation of financial markets was accompanied by a countervailing force of fragmentation? What if the main battlefield was among exchanges but between exchanges, on the one hand, and their main customers and erstwhile shareholders - large financial institutions, on the other hand? It may well be that the World War II, a war of shifting battlefields, bold movements and brusque position reversals, is a more appropriate comparison.
This alternative view is not far-fetched at all. As a matter of fact, it is considerably closer to the reality than the conventional wisdom of static consolidation. If one looks at the recent evolution of the US financial markets, the two marking and interrelated trends are:
- Continuing erosion of the market share of the two main equity markets, NYSE and NASDAQ. The case of NASDAQ is well-known and quite striking. In 2003, less than 20% of NASDAQ-listed stocks were actually traded on NASDAQ. This is despite (or maybe because of) the introduction in 2002 of a system, SuperMontage, which was intended as a killer of NASDAQ competitors (electronic communication networks, ECNs). The loss of market share by NYSE has been considerably smaller, held back by regulatory obstacles and aggressive strategy of Richard Grasso, long-time leader of NYSE. However, in the last two years, NYSE competitors have increased their share of trading from some 20% to 25% and it is expected that this trend will continue and may even accelerate
- Striking success of new entrants: Archipelago in equities, ISE in options, ICE in commodities. Archipelago was launched in late 1996 as one of the first ECNs. In mid-2004, it merged with Pacific Stock Exchange. By late 2004, it attracted over a quarter of transactions in NASDAQ listed stocks and some 3% of NYSE stocks’ transactions. The success of International Securities Exchange (ISE) is even more spectacular. Launched in March 2000, ISE has become the largest options exchange, ahead of such well-established exchanges as CBOE or Amex. InterContinental Exchange (ICE) was also launched in March 2000 to trade derivatives in energy and other industrial commodities. In 2001, ICE acquired the International Petroleum Exchange in London. This enumeration is far from exhaustive: several other new markets were launched in equities and fixed-income.
To be sure, the launch of new markets is accompanied by waves of mergers and acquisitions. More broadly, the market for financial markets is very active:
- IPOs (ArcaEx, ISE and ICE (filed on March 22, 2005)
- Intense interest in MTS and Instinet
The combined effect of these trends is the profound evolution of market structure and architecture. Within the emerging structure, NYSE and NASDAQ will remain important poles but their relative position is likely to change significantly.
The new architecture of financial markets is characterised by a “networked fragmentation”, a simultaneous proliferation and integration of market venues. If this architecture resembles that of the Internet, of a “network of network,” this resemblance is not coincidental, it is driven by the same technological and economic logic.
It is difficult to believe that European financial markets will not follow the same logic. As important as the LSE battle is, we need to look for the signs of the emerging new structure and architecture. Entrepreneurs should actively explore opportunities for new market entry and policy makers ensure that their efforts are not hampered by overzealous regulators.