Exchanges Are National: Time to Drop the Deutsche Boerse - LSE Merger

A listed exchange is a public company and a national treasure, a dual identity to be embraced. Can the Deutsche Boerse - London Stock Exchange deal succeed in the corporate sense and also in the fulfilment of exchanges’ obligations to the public good? History has demonstrated that building cross-border securities exchanges is not only hard, but it has the propensity to fail.

What does a regulated exchange do in the European Union these days, and what should it do in the future? If an exchange's essential corporate function is to organise public, regulated markets for the issuance of the nation’s securities and the listing of related derivatives contracts – and afterwards, secondary market pricing – then would a cross-border merger enhance that work?

The competition aspects of the proposed Deutsche Boerse - LSE merger are being examined elsewhere. I ask another question: Can this deal succeed in the corporate sense and also in the fulfilment of exchanges’ obligations to the public good? What is being put forward that would enhance the UK’s and Germany’s capital formation processes?

Irrespective of Brexit and the UK-EU arrangements to be settled in the coming years, I would argue that securities exchanges are part of the national landscape. They are infrastructures embedded in the workings of a society and its economy. They shape that society and economy. The shares and bonds issued to the public on that exchange are more familiar to, and more readily supported by, citizen-investors than the foreign certificates also listed. This applies even as participants look ever more beyond national borders.

History has demonstrated that building cross-border securities exchanges is not only hard, but it has the propensity to fail. This holds true in the supranational environment of the European Union, where close cooperation has not necessarily led to success. A few examples are relevant today in this era of computerised trading and cheap communications. The buzzwords "global" and "world-wide" might have led us to postulate a different outcome.

1. Euronext has had multiple configurations since its launch with the Belgian, Dutch and French national exchanges in 2000. The trio went on to include the Portuguese bourse, and then LIFFE. It was later sold to the New York Stock Exchange, and afterwards in an about-face was spun off by NYSE without its LIFFE component. It continues to operate, but it swims against the powerful current of its constituent nations’ diverse financial needs and ways of functioning.
2. Securities exchanges differ from options and futures exchanges, which can and do cross borders with relative ease. The underlying goods being priced are not tied to an asset class that is specific to any one jurisdiction – with the exception of equity options, and their pools of liquidity are never far from the underlying stock exchange listings, with their supporting cash market prices.
3. Mergers of exchanges within a single jurisdiction do work. Specific areas of expertise have been reinforced, as in the Canadian and Japanese exchange tie-ups. Scaling up to gain efficiencies has worked for the Spanish and Swiss markets. In the United States, the regroupings of exchanges within multi-service corporations has broadened the offer. But to demonstrate the contrary, German economic success has had support from an alternative view, namely that its regional exchanges provide unique and critical social and financial value by staying close to customers.
4. The initial tie-up between the bourses in Stockholm and Copenhagen also worked well. It was pragmatic, based on prior years of harmonising listing rules and building a common trading platform. Much goodwill was put into it, and both societies knew one another well enough to inspire confidence in this cross-border exception.
5. The current bid between Frankfurt and London is the third iteration. A Deutsche Boerse - NYSE tie-up also failed some years back. If it is so hard to do, what is the point of trying? How would we judge its success anyway, given the broad mandate of an exchange?

If one believes in the intrinsic value of a publicly regulated market that provides finance to enterprises and investment opportunities for savers, then nothing yet discovered beats the national economic barometer that is a securities exchange. The proposed Deutsche Boerse - London Stock Exchange tie-up appears to be centred on cost savings, but what about growth for the capital market? What about growth shares, the small-cap nursery that provides a unique socio-economic service to the country?

No publicly listed company can be run for the sole purpose of increasing shareholders’ gains at the expense of all else, because corporations have multiple stakeholders. More, a listed exchange is a public company and a national treasure, a dual identity to be embraced. Investors who hold shares in exchanges benefit from the aura of owning part of a centrepiece in the nation’s financial system, an intangible, impossible-to-quantify quality, which adds to the attractiveness of their holding. Yes, a listed exchange should earn profits – it is itself exemplary of our liberal market system, and it must succeed as a viable concern within a heavily regulated environment.

Every security issued has its unique story, and securities are meant for trading. Yet shares in a national bourse are surely about more than an asset that can simply be flipped: Its listing standards create a bond between issuers and investors by guaranteeing a certain contractual performance in exchange for calling on the public’s savings. A market with effective surveillance matters for fair access and proper execution of agent duties. These ancient principles have not lost their value, though US and EU legislation for most of the past two decades has regrettably pushed them aside.

There is the further problem of multiple infrastructures operated within these bourse groups, with the financial risks that they concentrate. Although exchanges operate relatively "risk free," clearing houses do not. The segment is already heavily skewed world-wide, and is still subject to profound regulatory and commercial transformations post-2009. Given these groups’ significant holdings in infrastructures, this merger would pose mammoth risk management questions.

Blurring the Lines

The United Kingdom is now reordering its position in Europe and the world; no one knows how its new relations will be defined, yet this is a secondary point for this proposed merger. Fair competition is a critical concern, and another is post-trade risk management. But my principal worry is how this deal would blur managements' focus and restrict resources that should be put into growing public market operations. The results of past deals lead me to doubt. And why arrange a deal if it were not to change the business focus?

If these exchanges can give the public assurances on public good work in a future conjoined structure, let them be given forcefully - and let their managers be held to these commitments via long-term pay-packet clawbacks. After all, other publicly listed exchanges have the public good as their statutory priority, before any strictly commercial considerations.

Today, banks are constrained in their lending activities. Private financings are filling the gap, but they do not offer ready, fair access to all, or enable what only an exchange does best: multilateral public pricing of the nation’s largest marketable assets. To keep the British and German economies on track at this time of multiple global uncertainties and a slowly transforming financial system, the LSE and Deutsche Boerse groups should concentrate on doubling down to organise financings for enterprises and attractive propositions for the investment community. It is a time for enhancing the fundamental values and institutions of Germany and the UK, and these go far beyond what is “just a share price” at a moment in time.

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The author, Thomas Krantz, is Senior Advisor, Capital markets, in the firm of Thomas Murray; and served as Secretary General of the World Federation of Exchanges (2000-2012). The views expressed are his own, and not necessarily those of the firm.

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