The merger of two of the big challenger exchanges in the US that was unveiled on Monday is another indicator that the global exchange consolidation, which had been slowed by regulatory obstacles and cultural issues, is stirring again.
The merger of BATS Global Markets and Direct Edge Holdings would create the second-largest US stock exchange, closing in on the New York Stock Exchange and isolating Nasdaq, the incumbent number two.
BATS and Direct Edge are both privately held, owned by investment banks, traders, hedge funds and private equity. Both emerged as technology based challengers to traditional exchange like the NYSE, and have played a significant role in undermining the profitability of traditional cash equities trading.
The merger would give them the scale and efficiencies to compete even harder with the NYSE and Nasdaq at a time when the profitability of cash equities trading is under pressure, as intense competition and fragmentation of trading has interacted with declining trading volumes.
The NYSE itself is involved in a slow-moving acquisition with its parent, NYSE Euronext, which agreed to be acquired by Intercontinental Exchange last year. That deal has been inching through the complex regulatory approvals processes.
Last year, the Hong Kong Stock Exchange beat off rival bids to acquire the London Metals Exchange. Earlier this year, the Tokyo Stock Exchange and the Osaka Securities Exchange announced plans to merge.
The resumption of merger activity among international securities exchanges that followed was a two-year or so hiatus during which something close to $US50 billion of transactions — including the proposed merger of Singapore’s SGX and our own ASX — was either frustrated by regulators or simply failed.
Driving the renewed interest in mergers are the ever-thinning margins available within the traditional cash equities business and a significant drop-off in equities trading volumes in the aftermath of the financial crisis.
The growth areas for securities exchanges are mainly in derivative products and in the potential growth in derivatives trading on regulated platforms as part of the post-crisis response by regulators to drive over-the-counter derivatives into more transparent marketplaces. There’s also been a big increase in the sale of market data and high-speed access to trading platforms to high-frequency and algorithmic traders.
ASX’s attempt to merge with SGX, which would have been effected by SGX acquiring ASX, was blocked by Wayne Swan on national interest grounds, ostensibly related to concerns about the control of clearing and settlement of Australian securities being transferred offshore.
ASX has made clear its continuing interest in the consolidation occurring offshore now that it faces competition from Chi-X in its cash equities business. London-based LCH Clearnet, which had been seeking approval to offer clearing and settlement facilities in this market, was given a more limited approval earlier this year to clear over-the-counter derivatives.
While ASX’s core clearing and settlement monopoly for cash equities, futures, options on futures and contracts for difference has been protected for two years, ASX would be very conscious that, in the longer term, the clearing and settlement functions, its cash equities business and its dominance of local derivatives activity are likely to face more substantial competition and loss of market shares.
One of the byproducts of the Federal Government’s review of the merits (or otherwise) of introducing competition to ASX in clearing and settlement of cash equities is that it recommended a voluntary code of practice with its major stakeholders that allowed user input into the strategies and designs of its facilities, greater transparency of pricing and protocols for ensuring fair and timely access to its platforms. ASX has taken these recommendations on board.
The regulatory reviews of domestic clearing and settlement since Swan's rejection of the merger with SGX, ASX’s response to them, and the demonstrated interest of other players entering the market have lessened the prospect that it would be as significant a roadblock to future cross-border strategic activity.
There is a belief in the market that should a Coalition Government emerge from next month’s election, it would be more amenable to the ASX being involved in a cross-border merger than Labor.
In an era of consolidation after the global financial crisis, regulatory encouragement for transparent trading could lead to a small number of global platforms dominating securities markets activity because markets are dominated by the big international investment banks and institutions.
ASX, one of the bigger securities exchanges by market capitalisation, could be eventually rendered irrelevant. It could also be destabilised by the emergence of those larger cross-border amalgamations.
Whether that means revisiting the SGX merger on different terms (the two exchanges now have almost identical market capitalisations whereas at the time of the merger announcement SGX was markedly more valuable) isn’t clear. There was a strategic logic to combining with an Asian securities exchange; SGX was the most logical available partner.
Despite ASX’s recent $553 million capital raising, which allowed ASX to increase the capital supporting its derivatives clearing house and emerge with no net debt, there are no signs that Elmer Funke Kupper is as yet on the prowl.
With every offshore exchange merger, however, ASX will be forced to think even more intensely about its longer term position within a far more globalised securities markets environment.