Financial exchanges. Shareholder power

Under pressure from shareholders, Europe's exchanges mull their options

FIVE years ago members of the London Stock Exchange (LSE) voted to take the 200-year-old institution public. On the continent, Germany's Deutsche Borse and Euronext - an amalgamation of several other European bourses - followed suit in the next couple of years. Demutualisation turned Europe's exchanges from organisations owned by and run for their customers, mainly big banks and brokerage firms, into companies expected to maximise shareholder value. At first, banks were shareholders as well as customers, but many sold their stakes to raise capital. Some of them may be kicking themselves today, as the money managers and hedge funds that now dominate the exchanges' boards reap the benefits of rising share prices and greater clout.

The clearest sign of shareholder activism was the ousting in May of Werner Seifert, chief executive of Deutsche Borse, for pursuing his courtship of the LSE. The latest came on November 1st. Atticus Capital, a fund that owns stakes in both Euronext and Deutsche Borse, called for Euronext to end its own lengthy wooing of the LSE and start merger talks with the Germans instead. The same day, Britain's Competition Commission ruled that bids by both continental exchanges for the LSE could proceed, subject to certain conditions. Euronext's management is believed to be open to talks with Deutsche Borse but, having been snubbed in the past, is waiting for the Germans to move first.

It may be that Reto Francioni, who took over as Deutsche Borse's chief executive this week, is more willing to talk to Euronext than Mr Seifert was. However, the practicability of a merger remains in question. A marriage of the two main continental exchanges would be likely to raise regulatory concerns. The two also have very different business models.

Euronext says it is mulling its options. "Whatever we do, it has to create shareholder value," says an adviser close to the exchange. "We can't do this on strategic value alone." Similarly, LSE shareholders, buoyed this week by good financial results and a promise that the company will return GBP250m ($444m) to them, are unlikely to accept anything less than a strong offer.

While shareholders flex their muscles, customers sound frustrated. "Users are concerned the exchanges have too much control," says Michael Long, of Keefe, Bruyette & Woods, an investment bank. As the London Investment Banking Association has moaned, the cost savings being wrung out of today's leaner exchanges are not being passed on to them. The LSE, for one, has raised its trading fees. The news this week that Eurex US, Deutsche Borse's answer to America's big derivatives exchanges, could close if it does not find a local trading partner is another blow to users, who enjoyed lower trading fees on the Chicago Board of Trade after Eurex US launched its challenge. Recently the Board of Trade has signalled that fees will rise again.

The irony is that exchange users were leading proponents of demutualisation several years ago. Although it is not clear that users have lost out entirely since then - product innovation, operational efficiencies and (at least temporarily) lower fees have all benefited them - their search for alternative trading outlets in both America and Europe indicates a desire to gain new leverage.

In America, a clutch of big exchange users - Citigroup, Credit Suisse First Boston, Morgan Stanley, UBS, Merrill Lynch and Citadel Derivatives Group - bought stakes in the Philadelphia Stock Exchange recently, as a way to counter the growing power of the New York Stock Exchange and NASDAQ. Four big investment firms then announced plans to create a new Boston-based electronic stock exchange, which is not yet operational. In Britain, says Mr Long, there is growing interest among large banks in "internalising" trades off-exchange - matching customers' buy and sell orders before sending net trades to exchanges. This already goes on, but does not yet make sense on a large scale. Nonetheless, he says, this could be a threat to the exchanges in the longer term.

For now, the exchanges' shareholders are much happier than users. Emboldened by the ditching of Mr Seifert, they are unlikely to stop telling executives what they think of their strategies.