European securities exchanges. Courting and competing

Consolidation is welcome, so long as trading costs fall

HAS the time finally come for the 203-year-old London Stock Exchange (LSE) to capitulate, gracefully, to a continental rival? This week Deutsche Borse, owner of the Frankfurt stock exchange and much else, approached the LSE with a £1.35 billion ($2.6 billion) takeover bid. The board of the London exchange rejected the offer after a day's consideration but decided to keep talking. That is good news for Werner Seifert, the dogged head of Deutsche Borse, who tried to snatch the LSE in 2000 but was ultimately rebuffed. This time around he seems to be using more delicate diplomacy. And yet a bidding war is still possible if Euronext, which operates stock exchanges in Paris, Amsterdam, Brussels and Lisbon, also makes an offer for the LSE.

This rush of activity is welcome. The LSE, though the most liquid stock exchange outside America, may need a partner if it is to grow. Besides incurring high costs from a new building and technology investments, it has diversified only minimally out of equities, where revenue growth has lately been slower than in the trading of financial derivatives (a mainstay of both Deutsche Borse's and Euronext's trading empires). And when exchanges merge, back-office costs fall and liquidity gets a boost. Europe's exchanges have already consolidated to some degree, and now seem likely to evolve into two competing giants headed by Euronext and Deutsche Borse.

Consolidation among exchanges is not, however, an unadulterated good. The principal danger is oligopoly pricing. Slashing costs by combining, say, the electronic-trading infrastructure of two exchanges has little public merit unless some of the benefit is passed along to customers who buy and sell shares. The reality, however, is that Europe's exchanges already operate with little competition. A German company is unlikely to list in London instead of Frankfurt, and vice versa - so exchanges have plenty of captive customers and pricing leeway. Many already face gripes about high prices - indeed, the LSE was forced to cut its listing fees by more than a quarter this year following a probe by Britain's Office of Fair Trading. In bidding for London, Mr Seifert has promised a “material reduction” in tariffs to London's users.

Which watchdog?

Regulators must keep a close watch to make sure that efficiencies are passed on to customers, regardless of what form the LSE's future takes. That raises the question of which regulators would look after a merged exchange. The LSE is supervised by Britain's Financial Services Authority (FSA). Deutsche Borse is regulated by the state of Hesse, with some input from the federal BaFin regulator; Euronext by various authorities around Europe. Deutsche Borse sources argue that merged exchanges do not need a lead regulator. But could the FSA still have robust oversight of an exchange whose ultimate bosses sit in Frankfurt? All this should be spelled out clearly before any deal is allowed to go ahead by regulators.

Users of exchanges, though, need more than just regulatory watchfulness. They will benefit most if exchanges carry on competing as well as courting. When exchanges raid one another's territory, trading gets cheaper, fast. Earlier this year Deutsche Borse took the Eurex derivatives exchange, which it half owns, into America to challenge exchanges in Chicago. The Chicago Board of Trade cut prices in response to the threat. Likewise the London Stock Exchange tried to snatch trading in Dutch equities by offering much lower prices, forcing Euronext to slash its prices too.

Such ventures are rarely successful in the short term, as stealing liquidity is tough. But continued competition is welcome. American exchanges could move into Europe; so too could online platforms, which have been slow to take off there. And bigger brokers can always choose to bypass exchanges altogether, and keep trades in-house, if they feel that exchanges' fees have got out of hand. Consolidation, and the fate of the LSE, should not be the end of the story.

Editorial which welcomes proposals to consolidate European stock exchanges - but only as long as trading costs fall.

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