So the LSE is going to ‘merge’ with Canada’s TMX. (I use the word ‘merge’ advisedly – as with all mergers there is one leading partner. In this case, despite protestations of a merger of co-equals, it is the LSE.) When the two organisations become one this will bring the new entity up to seventh in the world by market value according to the FT. Seventh? Whatever happened to the London Stock Exchange? Back in the 1980s it was one of the top three exchanges in the world, together with the New York Stock Exchange and the Tokyo Stock Exchange. Today the LSE has been overtaken by Deutsche Börse, the CME Group and even Brazil’s main exchange amongst others. Why?
Back in the 1980s exchanges were effectively monopolies owned by their members, the practitioners. These were, in the case of London, jobbers (i.e. market makers) and small agency brokers. On the continent exchanges were similar monopolies run by brokers who passed down their membership from father to son, often bolstered by legislation that required all transactions in shares to be channelled through the exchange. In New York the NYSE was run mostly by and for the benefit of the specialists. Many of these exchanges had fixed commissions (abolished in the US nearly a decade before the UK got around to it at Margaret Thatcher’s behest). This meant that to be an exchange member was to sit and watch the money roll in.
All that changed with Big Bang in London in 1986. This abolished fixed commissions, opened up stock exchange membership to foreign firms and enabled the LSE to take its first hesitant steps towards electronic trading. But it also alerted the competition to the challenges and opportunities out there. And the exchanges that were first to capitalise were those that realised that henceforth exchanges had to behave just like ordinary companies and seek to maximise profits. It took London a long time to learn this lesson. The Deutsche Börse, in particular during the tenure of Werner Seifert, learnt this lesson very quickly. The Paris Stock Exchange (which later became Euronext) learned the same lesson under the leadership of Jean-François Théodore shortly after. While Paris and Frankfurt were rapidly becoming highly commercial in their dealings, the LSE was led by a succession of relatively ineffective CEOs. It was only when that position was filled by Clara Furse that things began to change. Although Clara had a significant commercial background (and, crucially, a good knowledge of derivatives trading having been Deputy Chairman of LIFFE) by the time she came on board London was already lagging well behind the competition. And so instead of driving the exchange in the same commercial direction of the competition, Clara found herself fighting off bids from Deutsche Börse and Nasdaq. Her biggest failing was her inability to acquire LIFFE when she lost out in a bidding war with Euronext. Had the LSE kept up with the competition it would have been leading the consolidation rather than hiding from it. Clara’s main contribution was to acquire the Italian exchange, but this did little to improve the standing of the LSE.
Clara gave way in due course to the current CEO, Xavier Rolet, and at long last he seems to be bringing the sort of commercial acumen to the job that Seifert did for Germany and Théodore did for France. But the game has moved on in the meantime. Several trends have conspired to make his task that much more difficult. First MiFID came along and gave MTFs the ability to compete against established exchanges. The MTFs have taken full advantage of this and are eating into the market share of the established exchanges. Secondly the banks no longer treat exchanges as their property but as their competitors. Several large investment banks now operate their own MTFs or else have a shareholding in other MTFs. Thirdly the rapid growth in derivatives business (which can only increase with the current desire of regulators to bring OTC derivatives business onto exchanges) leaves exchanges without a derivatives business in a very exposed position. It is notable that the world’s second largest exchange by market cap is the CME, the Chicago based centre of derivatives trading. And the major equity exchanges larger than the LSE, such as NYSE Euronext and the Deutsche Börse, have very important derivatives business. It is possible that by merging with TMX the LSE will finally begin to address this gap in its armoury, but it is very late in the day. And as I write the news breaks of a possible merger between NYSE Euronext and the Deutsche Börse.
Xavier Rolet’s deal with TMX is a very welcome step, but it can only be a step. The MTFs are still eating into the business of the exchanges, the banks are increasingly acting as competitors to exchanges and the increase in derivatives business TMX brings to the table is welcome, but it pales in comparison with that of some of the LSE’s competitors. If the LSE is ever to recapture the leading position it had in the 1980s Rolet will need to do other deals. But the best deal left was a merger with Deutsche Börse. If NYSE and the Germans get together it will be game over for the LSE as all the biggest players will have been taken.