Financial exchanges. The Australians fold their tents

Europe's exchanges cannot afford to relax, despite Macquarie Bank's defeat

MACQUARIE BANK, an acquisitive Australian institution that dared to tilt at the London Stock Exchange (LSE), may be feeling a little bruised, having in effect withdrawn its bid this week. But it is possible that history will judge Macquarie more kindly than its detractors do today. Its bid pushed the LSE into returning more cash to shareholders than it might have done otherwise, and more quickly. And it was not afraid to make the helpful observation that national exchanges share some characteristics with utilities.

Predictably, this analogy upset exchange executives in both London and continental Europe. The Australians were derided from the outset (they might run toll roads and airports, but what did they know about exchanges?) and their bid of 580 pence ($10.20) a share was left trailing by the market's increasingly bullish view of the LSE's worth (see chart). Their defeat also caused a few giggles at the expense of Goldman Sachs, its investment bank, which had also advised Deutsche Borse, a German exchange group, on its own failed bid for the LSE last year.

Yet this is no time for the managers of the LSE or its continental counterparts to relax. Demanding shareholders and users, as well as broader structural changes in the industry, are keeping their feet to the fire.

Deutsche Borse acknowledged as much on February 21st when it laid out a strategic plan that trebled its dividend, to euro2.10 ($2.50) per share, and expressed qualified enthusiasm for marriage to another exchange. It now considers Euronext--a pan-European group that has also wooed the LSE--"by far the most attractive among a large number of relevant options". The two have discussed a tie-up in recent months, but talks became snagged on matters ranging from where the headquarters would be (the Germans favour Frankfurt, Euronext does not) to questions about clearing and settlement.

While Macquarie was not the first to note that exchanges throw off a tremendous amount of cash, its bid for the LSE reminded shareholders "how far you could leverage the balance sheet," says Andrew Mitchell of Fox-Pitt, Kelton, an investment bank. "Macquarie helped investors crystallise their thoughts." Last week the LSE said it would double the cash returned to shareholders. Deutsche Borse returned euro800m in share buy-backs and dividends in 2005 and plans to return another euro700m by May 2007. Euronext is also mulling a return of capital, and will unveil its plans on March 14th.

Exchange users, notably big investment banks, say that they too should benefit from growth, through lower fees. This week they met to urge Charlie McCreevy, the European Union's internal-market commissioner, to push for a more open cross-border system of clearing and settling share trades. Britain's competition authorities have already said that Deutsche Borse or Euronext must sell some clearing holdings if they want to pursue the LSE.

In the past, Mr McCreevy has favoured letting the market provide a solution on cross-border clearing and settlement, while noting that it remains costly and inefficient and puts "an unacceptably high burden on cross-border investment" in Europe. People who attended this week's meeting say that he may now consider issuing a directive if he finds the economic arguments persuasive. A decision is due in the second quarter. "I'm optimistic liberalisation is going to come about" in clearing and settlement, says Alberto Giovannini, who chairs a group of European financial-services firms. But, he adds, consolidation is likely to be "messy and choppy".

Not surprisingly, exchanges with their own clearing and settlement operations--notably Deutsche Borse and Euronext--are more resistant to regulatory intervention. Even so, Deutsche Borse this week sounded a bit more conciliatory than usual about various possible formats for a single European equities clearing operation. The exchanges may be loth to admit it, but a growing number of market observers think that such post-trade services are a bit like utilities, and perhaps should be run and regulated in the same way. A little like the Australian way of thinking?

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