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“Being the president of a stock exchange isn’t the most secure of jobs,” says Bengt Rydén with a chuckle. He should know. He has been in charge of the Swedish bourse for over 10 years, but has had to put his job on the line several times to force change on members. The Stockholm bourse has become surprisingly well known. It was the first in Europe to introduce remote access, which gives intermediaries without a local office the opportunity to trade on the Stockholm Stock Exchange via an electronic link. Other stock exchange chiefs who still have a few rounds to go in the fight over electronic trading, remote access, the local brokers’ monopoly and other sensitive issues listen with respect as Rydén explains his three-stage strategy. First, in 1989 Stockholm abandoned floor trading and went electronic. Second, by 1993 it had become a private company which gives issuers and investors an equal say with the brokers. The third stage, which began in 1993, was to go international by introducing remote membership. Rydén persuaded the Swedish parliament to approve the scheme in 1992 so it was ready long before Sweden joined the EU at the beginning of 1995. Thanks to its head start, this medium-sized exchange now has more remote members than any other bourse in Europe. In one country after another, intermediaries are taking up the opportunities offered under the EU’s investment services directive (ISD) by gaining remote access to more of Europe’s bourses. Since 1994 Frankfurt’s Deutsche Börse has set up remote access points in London, Amsterdam, Paris and Zurich, and has attracted 44 remote members. Another 14 brokers have opted for a direct link. Frank Mattern, a specialist consultant at McKinsey, who advised Deutsche Börse on its Zeus remote access strategy, expects the number of remote members to swell to at least 100 within three to five years. Thanks to the ISD it now makes sense for large intermediaries to concentrate much of their trading, together with risk management, in a single centre. Bayerische Vereinsbank has opted for its home town of Munich on the grounds that location gives no particular advantage, while Deutsche Morgan Grenfell’s more conventional choice is its vast new trading floor in London. The balance of power has passed to the intermediaries, and away from the stock exchanges and the state regulators who control them. Electronic natural selection Over the next five years, Europe’s stock exchanges will have to get used to competing with each other. Stockholm has been the first to introduce remote access, but electronic trading, price, efficiency, investment in improved technology and the struggle to maintain liquidity will also determine which bourses will come out on top. “No legal monopoly prevails any more, so issuers and investors are free to leave us for greener pastures if they find our services below par or our prices uncompetitive,” says Rydén. Deutsche Börse’s chairman Rolf Breuer believes that a process of natural selection among bourses is inevitable, since Europe has 32 spot and 23 futures exchanges “with more or less the same structure and products”. He argues that their numbers are bound to decline. “The US market is vastly more competitive, expert and creative than anything we can offer on this side of the Atlantic,” says Breuer, his choice of words indicating that this includes London, not just continental European bourses. What’s more, entirely new competitors will spring up to challenge the existing stock exchanges. Werner Seifert, chief executive of Deutsche Börse, warns that the number of competitors is increasing more quickly than he had expected. “The threat is less from the traditional competitors we know well,” he says. Instead, unregulated electronic exchanges will make the running. At present all Europe’s stock exchanges benefit from regulations that essentially give them a legal monopoly in their home markets, but that is expected to disappear in most countries within 10 years. Deutsche Börse’s strategy is therefore to offer “the full range of securities-related services” not just trading in an attempt to distinguish itself from emerging competitors such as Tradepoint. Market participants are divided on whether Internet trading is a threat. Jean François Théodore, chairman of the Société des Bourses Françaises (SBF), is confident that the Internet cannot offer the mechanisms for clearing and settlement; others insist it’s merely a matter of improved security before retail investors can buy and sell securities on-line. What’s certain is that the traditional stock exchanges will have to make the most of their track records. “The [established] stock exchanges have the goodwill of integrity and of institutional authority,” says Stockholm’s Rydén. “We must now capitalize on this.” Bourses will also need to be efficient low-cost operations in order to fend off these new trading networks. “Bourses are really just systems houses,” says Mattern at McKinsey. For a start, competition will force down trading fees. Stockholm’s charges have been reduced to $2 per trade, one-third of the level five years ago, and the brokers are passing that reduction on to customers. In turn, Swedish brokers have recently begun to cut their prices almost daily: one local member charges institutional investors just half a basis point in commission, while Enskilda lowered commission, at a stroke, by 30% in June. Likewise, Amsterdam charges no trading fee for deals channelled through its new electronic IBIS system. As a result, IBIS now handles 10% of Amsterdam’s volume. Giles Vardey, market development director at the London Stock Exchange, boasts that his costs have been reduced to just one basis point or 0.01% of volume. That is still 10 times higher than Stockholm. Other bourses would rather not mention their cost ratios. Mattern is not concerned that bourses will expire because they cost too much to run. “You have to ask yourself what is the minimum efficiency for a stock exchange. In fact, much of the cost is variable, so the minimum efficiency is quite low.” The biggest expense facing bourses is the introduction of electronic trading. For example, Deutsche Börse’s new EHS system is costing Dm150 million($101 million). Some smaller stock exchanges are further ahead than the larger ones, such as the London Stock Exchange and Deutsche Börse, largely because their electronic trading systems were simpler and easier to install. But their cousins are catching up fast. Increasingly, the small bourses will rely on larger or more advanced competitors for parts of their trading, clearing and settlement systems. The Paris Bourse has already sold its New Trading System in modified form to Madrid, Luxembourg and Bilbao. Likewise Deutsche Börse is hoping to resell EHS after its launch in 1998. More collaboration of this kind should avoid today’s wastefulness, where each bourse is investing tens of millions of dollars in new electronic trading systems. It will also allow even small exchanges to afford a sophisticated, up-to-date electronic trading system. No-one need be priced out of the market altogether. Despite the spread of electronic trading, brokers will stay in business, believes Boudewijn van Ittersum, chairman of the Amsterdam Stock Exchange, because major investors will remain reluctant to trade in the open. Brokers will be required as market-makers to prevent liquidity going to bigger centres such as London. What will happen, argues Ittersum, is that the number of brokers will be reduced. Already, Amsterdam’s 30 securities brokers have been reduced to seven, and their numbers could eventually be cut to about four, he says. The definition of a broker will change, too, as large fund managers decide to conduct trading themselves rather than rely on brokers. Mattern at McKinsey points out that all Germany’s big fund managers are, in legal status, banks so they are perfectly entitled to trade on the stock exchange. So far, their parent banks have presumably barred them from doing so in order to reserve the business for themselves. At the same time, investors and issuers will get more powerful as the Internet makes real-time market information accessible to the whole world, not just to members of the exchange or to banks. In Stockholm, unusually, investors already have access to the electronic order book, although only members of the exchange see the brokers’ names involved in each trade. So investors and issuers will have more say in the ultimate question of where liquidity will be in five years’ time. Even though a single European currency will not be fully introduced by 2000, it will almost certainly be widely used by large listed companies and thus by the capital markets. Once the euro is introduced Breuer expects portfolio managers to alter their approach overnight and to plan their investments by sector, and not by geographical lines. “It has become obsolete for a portfolio manager to focus on the little kingdom of his domestic market. In future, currencies will be obsolescent and the sector will be the focus of attention,” says Breuer. Guarding home-grown liquidity So it seems old-fashioned for Amsterdam, for instance, to claim to be the home of Dutch equities when several of those stocks are truly global. “Swiss stocks should not be able to find a way to bypass the Zurich bourse” is the aim of Otto Nägeli, one of the managing directors. Each of Europe’s stock exchanges aims to retain most of the liquidity in its own national blue chips. They are favoured by the fact that once liquidity is established it is very hard to shift. Germany’s futures exchange, DTB, managed to establish liquidity in Bund futures trading only when the big German banks made a concerted effort to withdraw their business from London’s Liffe and transfer it to Frankfurt. Nevertheless, DTB’s share of the market is still only about 30%. More intermediaries will soon spring up as investors start trading on their own behalf, but as newcomers to the trading community they will inevitably use the liquidity in the biggest centre, rather than trying to start a new pool of liquidity elsewhere. Moreover, remote access will allow brokers to do business in the largest pool of liquidity usually a stock’s home market rather than having to rely on the second-biggest pool, usually London. “The investment services directive has created a return to home markets,” says Rydén of Stockholm. “In the late 1980s many people thought that the mega-markets would take the lion’s share of global trading. Small exchanges that could not wage a fight based on service and trading costs would dry up and literally disappear. That hasn’t been the case.” Rydén believes that around 90% of Swedish share trading is still done in Stockholm, arguing that London claims the same lead only because it is counting double. Moreover, trading in German blue chips has largely desertedLondon’s Seaq and returned to Frankfurt ever since Deutsche Börse introduced IBIS, its first electronic trading system. Only when the bourses are completely deregulated, argues Vardey of the London Stock Exchange, will liquidity became mobile. “Then Daimler-Benz’s liquidity might come to London.” The nightmare of vanishing liquidity explains the sudden enthusiasm at several European bourses for promoting small- and mid-caps as attractive new market segments. Indeed, Deutsche Börse regards the development of these markets as its most important objective. Small- and mid-caps will always be dominated by domestic, not international investors. Therefore they are less likely than multi-nationals like Daimler-Benz to be driven away from their original bourses by powerful capital. The Nouveau Marché in Paris has already had seven initial public offerings since its launch in February and expects the number to grow to 30 by the end of the year. Frankfurt and Brussels are eagerly following suit, persuading domestic companies to list for the first time and inducing brokers to become active market-makers. While the multinationals will list in several centres, the small-caps will choose just one market: their own backyard. The exception will be technology firms, which are now regarded as natural candidates for Nasdaq and its planned European counterpart, Easdaq. Survival for all So the bourses will rely more on smaller issuers and also on retail investors. “Many banks can do without us tomorrow. We have to provide services for all investors,” says Vardey. A consoling thought: brokers’ margins are best in the medium-sized sector, too. So as long as each of Europe’s bourses can retain liquidity in a few stocks and operate efficiently enough to charge market prices, all should survive in some form. Strategists at Europe’s main stock exchanges now believe that “cooperation” will define their activities in five years’ time. Mattern at McKinsey believes that within five to seven years an oligopoly of three or four “clusters” will emerge, each centred on a European bourse. At the centre of each cluster will be the bourse that has the most liquidity and the most important stocks in a region. It will also have become a leader in developing trading, clearing and settlement systems, and selling them on to less innovative stock competitors. Because of the size and investor reach of its largest stocks, Frankfurt is bound to be at the centre of one cluster. Deutsche Börse has responded well by positioning itself as a pan-European service provider. It operates as a German institution and part of Finanzplatz the fact that it is in Frankfurt is now of secondary importance. Frankfurt’s potential satellites are the centres dominated by German issuers and investors: Vienna, Zurich and all the stock exchanges in eastern Europe. Potentially, Frankfurt could dominate the largest cluster of all and thus become the predominant stock exchange in Europe. The particular strengths of Paris are the electronic trading technology already sold to others and the lead it has taken by setting up the Nouveau Marché. The liquidity of France’s international stocks is also important. Stockholm has a good chance of becoming the centre of what Mattern calls the “Nordic cluster”. Remote membership has already attracted several brokers from Norway, Denmark and Finland: in April, foreign investors accounted for a record 44% of equity trading volume. The real unknown is the London Stock Exchange, which operates a liquid market in almost every important European stock but will not be able to offer remote access until its electronic trading system for the FTSE-100 is in place next year. Furthermore, as Vardey admits, prejudices against the LSE as a restrictive club which is insensitive to costs and stuck in the 19th century, still run deep. Which smaller European bourses will become satellites of London depends on the success of the electronic trading system. “The end game is access to European investors and issuers,” says Vardey. Although each national bourse will always have the bulk of liquidity in individual securities from its own country, Vardey points out that trading pan-European baskets of securities tends to happen in London already. The London Stock Exchange likes to compare itself with New York and Tokyo, not with European exchanges at all. The national stock exchanges on the edge of each cluster will turn into regional centres, like the seven illiquid regional markets found in Germany, and the two provincial exchanges in Switzerland and Italy. Cooperation will increase even between clusters, as the collaboration between Paris and Frankfurt shows. The much-hyped cooperation between these two cities may have withered to a scheme for producing a common front end for two separate trading systems, but it should be enough to make the two bourses a powerful force in Europe 2000. Although the two bourses decided that a single trading system would prove too expensive, they nevertheless hope to create a single front end, so that brokers can see Frankfurt and Paris on a single screen. Théodore of the SBF hopes that London’s Sequence electronic trading system, which is due to come on stream in May 1997, will allow a similar link with the London Stock Exchange. “We will keep in touch and have some kind of strategic committee,” says Théodore. “Most important is politics and the idea of cooperation,” he says hinting at the political considerations that dog the development of all European stock exchanges. Europe’s stock exchanges remain highly political organizations. Now that the threat to their continued existence has been acknowledged, politicians will be even more reluctant to see them disappear. But the future for Europe’s stock exchanges is not all bad. “Closing the local stock exchange is not something I see politicians doing,” says Mattern. “The bourse will continue to exist, even if it is only a window or a web site on a system.” |
