Fighting talk

FINANCE & ECONOMICS
The London Stock Exchange

Jan 20th 2005
From The Economist print edition

The LSE's two suitors spark a debate over market structure

ACCORDING to an online betting exchange, the odds against the London Stock Exchange (LSE) remaining independent have widened to eight to one. Deutsche Börse, a German exchange group, made a takeover proposal in December; Euronext, the product of mergers among the Amsterdam, Brussels, Lisbon and Paris exchanges, was quick to follow. Neither suitor has yet made a formal bid, but the LSE is in talks with both. The online bookies make Euronext the slight favourite.

Not all the would-be buyers' shareholders are happy. TCI, a hedge fund which says it has bought more than 5% of Deutsche Börse's stock, has called for the German exchange to buy back shares rather than overpay for the LSE. This is unlikely to worry Werner Seifert, Deutsche Börse's pipe-smoking, organ-playing chief executive: TCI would need to have owned its stake for three months to call a shareholders' vote. However, TCI's needling has exposed a weakness in Deutsche Börse's corporate governance. Its supervisory board, drawn mainly from the big banks that controlled it before its flotation in 2001, can hardly be said to represent the current, wider ownership. A small minority of Euronext shareholders also fears that their company's management might pay too much.

But many believe that the future ownership and governance of the London Stock Exchange may be too important to be left to shareholders alone, and that regulators will have to get involved. “This is about market organisation,” says a protagonist in the talks. Broadly there are two camps: those who argue that stock exchanges should not own or control entities that clear and settle trades, and those who argue that ownership does not matter, as long as each stage is open to competition.

Deutsche Börse, which owns clearing and settlement operations, is often seen as the more monopolistic, and Euronext, which does not, as the more customer-friendly. In fact both groups' clearing and settlement arrangements leave room for oligopolistic pricing. For example, some bigger members of the exchanges carry out internal or block trades without revealing prices. They also benefit most from offsetting buy and sell orders with a central counterparty, without obviously passing their savings on to customers.

Developments at the LSE, too, have not always been for the general good. Indeed, the introduction of a central counterparty has increased trading costs for some of the exchange's smaller members. Apcims, a British association of brokers and investors, has told the LSE that the merger must produce cost reductions in this area.

So national and European regulators will have to be keen-eyed, no matter who buys the LSE. The European Commission is well behind schedule in drafting a clearing and settlement directive that might have helped in this merger battle. The papers published so far avoid favouring any particular market structure. A group of clearing and settlement experts is not expected to give the commission its analysis of the regulatory implications of different market arrangements until September.

As a consequence, no one is sure what the future regulation of Europe's securities exchanges, clearing houses and central securities depositories will look like. The arguments being deployed in the fight for the LSE, both by the prospective purchasers and by other interested groups, are to some extent intended to push the market structure and its regulation one way or the other. The outcome of this debate will set the rules for what some see as the final stage. Whoever wins the LSE, it may only be a matter of time—five years, say some—before the three main exchange groups have merged into one.

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