Imprudent to resist takeover of the LSE

Europe’s bourses are in the headlines of European newspapers almost daily at present, which is probably overdone given their relatively small size in terms of revenue.

If it is not about alliances or takeovers, it concerns their responses to the challenges raised by the Markets in Financial Instruments Directive (MiFID) or other ongoing forms of market liberalisation. It should be no surprise that, in a business where scale matters, the responses go beyond European boundaries. After Euronext, it seems that the London Stock Exchange (LSE) may also become a transatlantic exchange. This is a logical evolution, given the strategic choice which the LSE made some years ago to focus on its core business of trading.

The business of exchanges today is composed of fairly distinct segments such as listing and trading, revenues raised from vending market data or providing settlement and selling information technology services. This fairly heterogeneous composition of services originates from a time when exchanges were state monopolies or mutuals owned by banks and brokers. Most European exchanges have in the meantime been privatised and started to adapt to the new context. Some exchanges, such as Euronext and the LSE, have chosen to strengthen their core business, trading, whereas others have focused on vertical integration to provide straight-through-processing to clients. The former have thus chosen to provide a single service at an increasingly global level, whereas the others have opted for a full set of services within a given market.

The coming into force of MiFID in November 2007 is a profound challenge for all the exchanges. In a nutshell, this directive brings more competition to all core businesses of exchanges. The directive abolishes the monopoly of exchanges in trading and allows banks to internalise, to make internal matches of trades. It no longer requires banks to pass on trade data to the exchanges, but allows them to sell the data to other firms, such as data vendors. It opens up the market for settlement by giving investment firms a free choice of the venue of settlement. In addition, the directive facilitates the creation of new exchanges or multilateral trading facilities (MTFs).

So trading revenue, which is about 42% of the income of the six largest EU exchanges (57% for the LSE), will come under pressure as a result of more competition from banks and other trading platforms, such as ‘Project Turquoise’, the initiative by seven investment banks to set up an alternative trading platform. The data vending revenues of exchanges, which is about 12% of the income of the six largest EU exchanges (32% for the LSE) will suffer from more competition from existing data vendors such as Reuters and Bloomberg, or new initiatives, such as ‘Project Boat’, an initiative again by investment banks to sell all their trade data to an MTF. Settlement, which is about 18% of the income of the six largest EU exchanges (LSE has divested settlement), may not be so directly threatened, although here also the market will be opened up, but there is another initiative looming which may profoundly change the market, ie, the Target 2 Securities project of the European Central Bank.

It is clear that the LSE, with 89% of its revenues stemming from trading and data vending, should be extremely concerned by MiFID.

Since internalisation is already possible in the UK, the LSE has already been more exposed to a competitive market than the other European exchanges. But with two single sources of revenue directly and immediately affected by MiFID, it is, more than the other European exhanges, vulnerable: the statement by the NASDAQ’s chief executive that "MiFID is one of the biggest threats to the LSE’s business in its 300-year history" is thus no bluff, but real.

In this context, it would be wise if the Financial Services Authority and the British establishment took a less protectionist attitude to the takeover by NASDAQ, just as it should have done to other European takeover attempts, such as those of Deutsche Börse.

The only way to survive for an exchange post-MiFID is to increase its scale or scope. For the LSE as for Euronext, this means integration with the capital market which is the closest to the European: the US. For shareholders, it is clear that, given the current share price and the developments sketched above, this is a golden opportunity to sell.

• Karel Lannoo is chief executive of the Centre for European Policy Studies. www.ceps.be

Europe’s bourses are in the headlines of European newspapers almost daily at present, which is probably overdone given their relatively small size in terms of revenue.