Stock exchanges. Crossing the pond

NASDAQ's bid for the London Stock Exchange has sparked a flurry of speculation about other tie-ups among exchanges

UNTIL this week, NASDAQ was best known in London as an American stock exchange loaded with technology firms that saw its index soar and then dive with the dotcom boom and bust. Now a revitalised NASDAQ is reaching across the Atlantic to grab a prized jewel in Britain's financial crown, the London Stock Exchange (LSE), which has already seen off several foreign bidders.

Londoners following the LSE bidding saga had become so used to guessing games about continental exchanges, notably the pan-European Euronext and Germany's Deutsche Borse, that the Americans' hostile bid late last week came as something of a surprise. It shouldn't have. NASDAQ tried unsuccessfully to enter Europe once before with a start-up and has in the past held tentative talks with the LSE. Its cash offer of pounds 9.50 ($16.60) a share, which would cost the Americans pounds 2.4 billion, makes the preceding bid-- pounds 5.80, from Australia's Macquarie Bank, only three months ago--look downright stingy.

NASDAQ's offer was rejected outright by the LSE's management, but is being considered by big shareholders. If the merger does go ahead, it would be a quantum leap in the consolidation of financial exchanges. It could also raise difficult questions of who should regulate the combined entity, and how. A merged firm would be second only to NYSE Group--as the newly listed New York Stock Exchange styles itself--in market capitalisation.

And even if the merger doesn't happen, the mere possibility illustrates convergent and accelerating trends among the world's exchanges. These include a shift from mutual ownership to listed exchanges, rapid advances in and dissemination of technology, and increasingly sophisticated users who want to trade across borders and asset classes. Meanwhile, exchange shareholders have not been shy to let managers know what deals they should and should not pursue--and that if the bosses do not listen, they risk losing their jobs.

Shareholders in most big financial exchanges are sitting pretty. The share price of the LSE soared by about 30% on March 13th, the first trading day after NASDAQ's bid was revealed, and touched pounds 12 later in the week. This reflected both the offer and the possibility of a bidding war, perhaps with the NYSE. NASDAQ's shares have also risen since the bid, as have the NYSE's, even though markets often take a dim view of acquirers.

The bid, made just days after the NYSE went public, has also focused the minds of exchange executives around the world. NASDAQ's New York rival filed plans on March 14th for a secondary stock offering, the proceeds of which could pay for an acquisition of its own. Its boss, John Thain, has made no secret of his desire to join forces with a European exchange. The NYSE said this week that it must be ready to respond "quickly and decisively" to consolidation. A complicating factor, though, is its continuing integration of Archipelago, an all-electronic exchange, and the roll-out of a "hybrid" trading platform that mixes electronic trading with its traditional open-outcry system.

Two other potential targets for the Americans--Deutsche Borse and Euronext--are back in the spotlight too. For ages the continental pair have been exchanging meaningful glances and having occasional talks. The chances of a tie-up looked a little more serious this week after NASDAQ's bid. Euronext, which this week reported fourth-quarter profits 53% up on the previous year and promised to return euro1 billion ($831m) to investors through a special dividend and share buyback, declared that it was eager to bridge its differences with the Germans. "There is a time for talk and a time for action," said Jean-Francois Theodore, Euronext's boss, when asked about the talks with Deutsche Borse. A little unhelpfully, the economics minister in the German state of Hesse, which licenses Deutsche Borse to operate the Frankfurt Stock Exchange, implied that the local regulator would insist on Frankfurt retaining the lead role in a merged entity.

The LSE is still believed to be receptive to an offer from Euronext, which beat it in a contest for Liffe, a futures exchange, several years ago. What the LSE lacks is diversity in asset classes, something it hoped but failed to secure with its pursuit of Liffe--and something that NASDAQ will not bring. Whether Euronext's shareholders want it to face NASDAQ in a bidding war is another question.

While stock exchanges ponder possible partnerships, executives at the world's big futures exchanges have scarcely been idle. The Chicago Mercantile Exchange, for instance, which has a big war chest, has established technology hubs in Europe and Asia, and is eager to expand its influence (see our survey of Chicago in this issue). Derivatives exchanges have done particularly well since going public, with soaring volumes and share prices to go with them. Those exchanges, such as the New York Mercantile Exchange, that have not gone electronic look increasingly out of step. Its decision this week to sell a 10% stake to General Atlantic, a big private-equity firm with investments in technology as well, will help push it in the direction of electronic trading.

But who regulates?

With a transatlantic merger looming, exchange users in London voiced concerns this week that they might be subject to American regulators in future. Britain is generally seen by international investors as a more welcoming regulatory environment than the United States, especially since America passed the Sarbanes-Oxley and USA Patriot acts. They worry that London's status as a world financial centre could be dented--although with the FTSE 100 stockmarket index at its highest for almost five years, the British investment climate looks pretty good for the moment.

Nonetheless, in the face of investors' worries about regulation, American and British financial regulators said on March 14th that they would co-operate more and share more information on cross-border financial institutions. NASDAQ issued a statement saying that London operations would continue to be regulated by Britain's Financial Services Authority (FSA), rather than by America's Securities and Exchange Commission (SEC).

But too little is known about NASDAQ's plans to be sure what the regulators' roles would be. According to an SEC official, a joint holding company with separate trading operations in America and Britain would require very little change in the regulatory environment. But regulators on both sides of the Atlantic might have more to say if the exchanges used a common trading platform, which NASDAQ has hinted at, or, going even further, common rules and listing requirements, the official added.

For the moment, the happiest people in the exchanges business might well be shareholders in the LSE. The past year has seen a succession of suitors come and go, and the share price rise and rise. Given the exchange's initial rejection of NASDAQ's offer, there is every chance that someone, maybe NASDAQ itself, will offer even more--though the American exchange's shareholders might have cause to grumble. Although NASDAQ's price-earnings ratio is well above the LSE's and its share price has recently risen, it earned a caution from Standard & Poor's, a rating agency, for pursuing the LSE so soon after paying $934.5m for INET, a trading platform.

Why so many bidders have been drawn to London is a question worth posing. The LSE's management has been competent, but it has also benefited lately from a bull market in shares. More important are the deep pools of liquidity and talent in London, its trading tradition and its ability to span time zones more comfortably than some. "The reason for London's success as a financial centre is not down to who owns the stock exchange," says Tim Plews, an expert on financial markets at Clifford Chance, a law firm. "We've accepted the idea of foreign ownership. The world won't come to an end."