When exchanges embrace and eat one another

When exchanges embrace and eat one another

Like their corporate counterparts, bourses world over, too, think being big is the only way to remain competitive

Jojo Puthuparampil

As traditional trading floors are becoming a distant memory, stock exchanges world over are trying to embrace and eat one another in order to expand reach and operations. The recent purchase of a 6 percent stake in the National Stock Exchange (NSE) by Morgan Stanley, Citigroup and private equity fund Actis is a brief act in a long consolidation drama being staged on the global financial markets, featuring leading bourses. The move by Morgan Stanley and others followed purchases of 20 percent in NSE by NYSE Group, Goldman Sachs, General Atlantic and Softbank Asian Infrastructure Fund (SAIF); as well as 5 percent in India's Bombay Stock Exchange (BSE) by German Deutsche Boerse for $910 million, and another 5 percent in BSE by the Singapore Exchange (SGX) for $42.6 million.

Against the backdrop of similar developments involving exchanges across the globe—NYSE's acquisition of Euronext, which runs exchanges in Paris, Amsterdam, Brussels and Lisbon; the Nasdaq Stock Market's pursuit of the London Stock Exchange (LSE), and attempts by NYSE and Nasdaq to form partnerships in Asia—these deals signal that the ongoing consolidation of global capital markets will gain momentum.

Bourses in India, whose gross domestic product grew 9.2 percent in the three months through December, second only to China among the world's major economies, are emerging active participants in the consolidation process. By picking up a stake in NSE after paying $115 million in cash, NYSE, the world's biggest exchange, made its first investment in Asia through the Indian market where the combined worth of stocks has risen 50 percent over the past two years to $820 billion.

What is happening in India is only a stray whiff emanating from a storm brewing elsewhere—almost all the world’s leading exchanges seem to be affected by the feverish consolidation contagion. LSE recently rejected a $4.2 billion take-over bid by Nasdaq. This was preceded by an unsuccessful bid for the London exchange by OMX, the Swedish Stock Exchange, in 2000. In recent years, LSE also rejected bids by Euronext by Deutsche Boerse, which runs the Frankfurt exchange, and by Macquarie Bank of Australia. In addition to the purchase of Euronext for $20 billion in June 2006, NYSE bought Chicago's Archipelago Holdings, a nine-year-old, all-electronic trading system, for $10 billion, in an effort to compete with all-electronic operations.

NSE, based in Mumbai and twice as big as BSE in terms of volume and value of the trade it carries out, handled a daily average of $2 billion in 2006. The 14-year-old exchange also dominates trading in equity-based futures contracts and owns stakes in the Indian National Commodity Derivatives Exchange and the Multi-Commodity Exchange. The transaction between NSE and the group led by NYSE and Goldman valued the Indian exchange at $2.3 billion. The deals involving the group led by Morgan Stanley and Citigroup will take foreign ownership of the NSE to 26 percent, the maximum allowed by Indian law. Morgan Stanley will buy 3 percent, while Citigroup will take 2 percent and Actis 1 percent.

"In a rapidly integrating world of financial markets, the partnership (with NYSE) brings together the strengths of institutions from North America, Europe and Asia. This alliance marks a significant milestone for NSE in developing a place for itself in the emerging global scenario. The global financial investors are amongst the most pedigreed institutions in the world, and will contribute to building value in the NSE," said Ravi Narain, managing director and chief executive officer of NSE, in a statement. The investment of NYSE, which has a market capitalization of more than $15 billion, is strategically important for NSE, he said.

"Indian exchanges are the best in the world when it comes to capital market transactions. However, local exchanges can learn from their foreign counterparts when it comes to derivatives and structured financial products," said Nilesh Shah, who manages assets worth $9.8 billion at Prudential ICICI Asset Management Company, based in Mumbai.

While the alliance with Goldman Sachs, which is a leading advisor to many of the world's major exchanges, will help NSE strategically, the deal with Softbank Asian Infrastructure Fund, which has over 60 portfolio companies in the region, will bring SAIF's extensive network of Indian as well as international relationships in the financial services sector to the advantage of NSE.

"Exchanges like NYSE already attract listings from around the world. Consolidation among exchanges across the globe would lend leading exchanges a stronger cross-border presence. Alliances among exchanges will also help investors better manage assets in foreign countries. As consolidation picks up strength, companies could list their shares in varied markets. But a listing in a different market would make sense only if it adds value to the stock in terms of valuation," said Vineet Suchanti, managing director of Mumbai-based consulting firm Keynote Corporate Services.

BSE, too, is aggressively forging alliances with foreign exchanges. The exchange has about 4,800 companies listed, a fully automated trading platform and nearly a billion dollars a day in turnover. Both NSE and BSE stand smaller in comparison with NYSE where $70 billion to $100 billion in shares trade each day. Though BSE is the oldest bourse in India, it trails behind NSE when it comes to attracting listings. It plans to sell 51 percent of its shares to partners and strategic investors in roughly 5 percent increments to enhance its operations and gain a technical edge.

BSE expects its alliance with Deutsche Boerse to strengthen its competencies, especially for trading in derivatives. The move in turn will help Deutsche Boerse to expand into Asia, and establish its presence in multiple time-zones and regulatory environments. Through the deal with the Singapore Exchange, BSE expects to capitalize on Singapore's position as a regional hub for derivatives and international listings.

"The Singapore Exchange is already listing a lot of GDRs (global depositary receipts) of Indian companies. Once the Indian rupee becomes a convertible currency - which is likely to happen in the near future – foreign exchanges such as SGX would be able to attract more Indian listings and increase trade," Suchanti said.

"Foreign exchanges are investing in India's long-term growth story," said Shah. "For Indian exchanges, tie-ups with their foreign peers would mean visibility, technology, and access to new financial products," he said.

Ownership

The Indian government lifted a ban on foreign ownership of exchanges in December last year. A single foreign investor can now own no more than 5 percent in any of the 22 stock exchanges in India. However, the total foreign ownership cap was raised to 49 percent under rules issued by the Reserve Bank of India. Foreign direct investment is capped at 26 percent, and foreign institutional investment at 23 percent.

Stocks on the Indian exchanges are some of the most richly valued in Asia, after the Sensex index of BSE jumped 45 percent in 2006. They are also volatile. The Asian market correction in the first week of March took some sheen off Indian stocks. Despite the volatility and fears of overheating, many argue that India's long-term economic prospects are too attractive for potential overseas partners to ignore. The efforts by foreign exchanges to form alliances with Indian peers mean that they would want to be a part of the growth the Indian market is likely to witness in the long run.

"Indian equities are most likely to continue to perform over a longer-term perspective, possibly much faster than many other emerging markets," said Shah.

Consolidation across the world

In fact, consolidation is becoming easier for stock exchanges now than ever before—through massive computers, fiber-optic cables, wires and satellite links. Consolidation also makes sense in many other ways. Clearing and settlement will continue to be cumbersome as long as exchanges remain fragmented. A large number of exchanges will also push up transaction costs. Consolidation makes trading easier for exchanges and brings in more liquidity. Bigger exchanges enjoy economies of scale that reduce trading costs, and attract more traders and listing companies. And as trading volume increases, it is easier for buyers and sellers to find one another. Added liquidity helps stock prices respond quickly to changes in supply and demand.

World over, shares are increasingly held by large institutions, who need added liquidity to manage huge trades; only large exchanges can offer this. Institutions are becoming sophisticated and cost conscious. Consolidation also brings a lot of transparency in transactions, which smaller bourses cannot offer.

Regulations

Tighter regulations make it difficult for US exchanges to compete with bourses in other countries, where regulations are not as stringent as in the US in attracting fresh corporate listings. For instance, the Sarbanes-Oxley law enacted in the wake of the Enron scandal makes company officials legally liable for the accuracy of their firms' financial statements. By acquiring foreign peers, US exchanges such as NYSE can serve listing companies that want to avoid harsher regulations in the US.

Like companies, stock exchanges also want to be 'big' to remain competitive in an integrated global economy. Those who don't join the race would just end up laggards. The purchases of stakes in Indian exchanges by their foreign counterparts reinforce this.

(This report was written a few years ago and the backdrop against which it was written has changed)