Stock exchanges. Coming together

The prospect of a transatlantic merger is long overdue

THE would-be acquirer was founded in New York 35 years ago as the world's first all-electronic stockmarket. Its quarry is one of the oldest exchanges, tracing its history back to the coffee-houses of 17th-century London. NASDAQ, based in New York, and the London Stock Exchange (LSE), which last week became its target, are as different as bull and bear.

But then pretty much every feasible exchange is caught up in the frenzied talk of consolidation just now. In the past 15 months the LSE has been pursued by a string of foreign suitors, from continental Europe and Australia. Deutsche Borse and Euronext, two big European exchanges that have eyed the LSE in the past, sound increasingly interested in merging with each other. The New York Stock Exchange (NYSE) may yet bid for the LSE or another exchange. Even Chicago's futures and options exchanges have become tangled in the speculation.

One world

These mergers are being seen as a step towards the creation of global financial exchanges, a glint in the eye of anyone for whom the existence of the national bourse is as quaint as the existence of the national airline. Even if the reality falls short of world exchanges, consolidation is long overdue for those who need capital or who have capital to supply. The question is what to do about the markets' regulators, still stuck back in their national--or even regional--bunkers.

In some ways NASDAQ's bid has been a long time coming ()see page 77. Its origins lie in three trends within the industry. The gradual takeover by electronic trading has shifted the economics of the exchanges. Users want speed and reliability--witness the Tokyo exchange's humiliating mess earlier this year when it was unable to handle the collapse of livedoor, a troubled internet and finance company. Speed and reliability lead to calls for expensive computer and communications systems, which become dramatically more profitable as they carry more trading. At the same time, exchanges have one by one abandoned their status as clubs and mutuals. This has created companies with the motive to expand, a clear-enough governance structure to allow for a strategy of expansion, and the currency with which to buy another exchange.

The third factor behind mergers is the demands of the exchanges' users--whether they are trading stocks, bonds, derivatives or commodities. The investment banks and hedge funds that account for a big chunk of the day's trading volume use complex strategies that leap across national borders and asset types. At the moment, these often require a patchwork of trades using different exchanges with different technology. Users dream of a time when even the most intricate trade will be possible by pushing a single button.

Everyone stands to gain from consolidation. The users win economies of scale, in the form of lower fees, and the ability to move capital quickly and easily across borders. Anyone raising capital can gain from the efficiencies, because more liquidity and cheaper trading will tend to mean a lower cost of capital. And the exchanges do well, too, because they can offset the fall in fees by higher volumes.

So where is the rub? One worry is competition. The exchanges will pass on the efficiencies only if they face the threat of business going elsewhere. Some of this can come from off-exchange trading, but users have no better safeguard than the sort of arch-rivalry that exists between NASDAQ and the NYSE. Thus far, European traders have benefited less from competition. More than a few investment bankers were furious this week when Euronext announced that it was returning euro1 billion ($1.2 billion) to shareholders--without cutting trading fees. That is one reason to prefer a transatlantic tie-up for the LSE over an all-Europe deal. With NASDAQ and the NYSE at each other's throats, if one were to win the LSE, the other would very possibly look elsewhere in Europe.

The second worry is regulation. As all that money and information whizzes around the globe, financial regulators--even the best-intentioned--too often get in the way. Prey to national politics and industry lobbying, regulators are not inclined to compromise across borders. (The state of Hesse, which regulates Deutsche Borse, this week sanctioned a merger with Euronext only if it bolsters Frankfurt's position as a financial centre.) On the other hand, a single global regulator would not only be impractical, but, unchecked by rivalry from market regulators elsewhere, would also be most likely to turn out a bad steward of the markets. Competition extends not only to big exchanges, but big regulators, too.