Stock market

investors and those interested in taking higher risks. For example, there

are tables showing the trading on several different exchanges in listed

options—primarily options to buy or sell common stocks (call options and

put options). There are futures prices— commodity futures and also interest

rate futures, foreign currency futures, and stock index futures. There are

also options relating to interest rates and options relating to the stock

index futures.

6. EUROPEAN STOCKMARKETS–GENERAL TREND

Competition among Europe’s securities exchanges is fierce. Yet most

investors and companies would prefer fewer, bigger markets. If the

exchanges do not get together to provide them, electronic usurpers will.

How many stock exchanges does a Europe with a single capital market

need? Nobody knows. But a part-answer is clear: fewer than it has today.

America has eight stock exchanges, and seven futures and options exchanges.

Of these only the New York Stock Exchange, the American Stock Exchange,

NASDAQ (the over-the-counter market), and the two Chicago futures exchanges

have substantial turnover and nationwide pretensions.

The 12 member countries of the European Community (EC), in contrast,

boast 32 stock exchanges and 23 futures and options exchanges. Of these,

the market in London, Frankfurt, Paris, Amsterdam, Milan and Madrid–at

least–aspire to significant roles on the European and world stages. And the

number of exchanges is growing. Recent arrivals include exchanges in Italy

and Spain. In eastern Germany, Leipzig wants to reopen the stock exchange

that was closed in 1945.

Admittedly, the EC is not as integrated as the United States. Most

intermediaries, investors and companies are still national rather than pan-

European in character. So is the job of regulating securities markets;

there is no European equivalent of America’s Securities and Exchange

Commission (SEC). Taxes, company law and accounting practices vary widely.

Several regulatory barriers to cross-border investment, for instance by

pension funds, remain in place. Recent turmoil in Europe’s exchange rate

mechanics has reminded cross0border investors about currency risk. Despite

the Maastricht treaty, talk of a common currency is little more than that

Yet the local loyalties that sustain so many European exchanges look

increasingly out-of-date. Countries that once had regional stock exchanges

have seen them merged into one. A single European market for financial

services is on its way. The EC's investment services directive, which

should come into force in 1996, will permit cross-border stockbroking

without the need to set up local subsidiaries. Jean-Francois Theodore,

chairman of the Paris Bourse, says this will lead to another European Big

Bang. And finance is the multinational business par excellence: electronics

and the end of most capital controls mean that securities traders roam not

just Europe but the globe in search of the best returns.

This affects more than just stock exchanges. Investors want financial

market that are cheap, accessible and of high liquidity (the ability to buy

or sell shares without moving the price). Businesses, large and small, need

a capital market in which they can raise finance at the lowest possible

cost If European exchanges do not meet these requirements, Europe's economy

suffers.

In the past few years the favoured way of shaking up bourses has been

competition. The event that triggered this was London's Big Bang in October

1986, which opened its stock exchange to banks and foreigners, and

introduced a screen-plus-telephone system of securities trading known as

SEAQ. Within weeks the trading floor had been abandoned. At the time, other

European bourses saw Big Bang as a British eccentricity. Their markets

matched buy and sell orders (order-driven trading), whereas London is a

market in which dealers quote firm prices for trades (quote-driven

trading). Yet many continental markets soon found themselves forced to copy

London's example.

That was because Big Bang had strengthened London's grip on

international equity-trading. SEAQ's international arm quickly grabbed

chunks of European business. Today the London exchange reckons to handle

around 95% of all European cross-border share-trading It claims to handle

three-quarters of the trading in blue-chip shares based in Holland, half of

those in France and Italy and a quarter of those in Germany—though, as will

become clear, there is some dispute about these figures.

London's market-making tradition and the presence of many international

fund managers helped it to win this business. So did three other factors.

One was stamp duties on share deals done in their home countries, which

SEAQ usually avoided. Another was the shortness of trading hours on

continental bourses. The third was the ability of SEAQ, with market-makers

quoting two-way prices for business in large amounts, to handle trades in

big blocks of stock that can be fed through order-driven markets only when

they find counterparts.

A similar tussle for business has been seen among the exchanges that

trade futures and options. Here, the market which first trades a given

product tends to corner the business in it. The European Options Exchange

(EOE) in Amsterdam was the first derivatives exchange in Europe; today it

is the only one to trade a European equity-index option. London's LIFFE,

which opened in 1982 and is now Europe's biggest derivatives exchange, has

kept a two-to-one lead in German government-bond futures (its most active

contract) over Frankfurt's DTB, which opened only in 1990. LIFFE competes

with several other European exchanges, not always successfully: it lost the

market in ecu-bond futures to Paris's MATIF.

European exchanges armoured themselves for this battle in three ways.

The first was to fend off foreign competition with rules. In three years of

wrangling over the EC's investment-services directive, several member-

countries pushed for rules that would require securities to be traded only

on a recognized exchange. They also demanded rules for the disclosure of

trades and prices that would have hamstrung SEAQ's quote-driven trading

system. They were beaten off in the eventual compromise, partly because

governments realized they risked driving business outside the EC. But

residual attempts to stifle competition remain. Italy passed a law in 1991

requiring trades in Italian shares to be conducted through a firm based in

Italy. Under pressure from the European Commission, it may have to repeal

it.

6.1 New Ways for Old

The second response to competition has been frantic efforts by bourses

to modernize systems, improve services and cut costs. This has meant

investing in new trading systems, improving the way deals are settled, and

pressing governments to scrap stamp duties. It has also increasingly meant

trying to beat London at its own game, for instance by searching for ways

of matching London's prowess in block trading.

Paris, which galvanized itself in 1988, is a good example. Its bourse

is now open to outsiders. It has a computerized trading system based on

continuous auctions, and settlement of most of its deals is computerized.

Efforts to set up a block-trading mechanism continue, although slowly.

Meanwhile, MATIF, the French futures exchange, has become the continent's

biggest. It is especially proud of its ecu-bond contract, which should grow

in importance if and when monetary union looms.

Frankfurt, the continent's biggest stock-market, has moved more

ponderously, partly because Germany's federal system has kept regional

stock exchange in being, and left much of the regulation of its markets at

Land (state) level. Since January 1st 1993 all German exchanges (including

the DTB) have been grouped under a firm called Deutsche Borse AG, chaired

by Rolf Breuer, a member of Deutsche Bank’s board. But there is still some

way to go in centralizing German share-trading. German floor brokers

continue to resist the inroads made by the bank’s screen-based IBIS trading

system. A law to set up a federal securities regulator (and make insider-

dealing illegal) still lies becalmed in Bonn.

Other bourses are moving too. Milan is pushing forward with screen-

based trading and speeding up its settlement. Spain and Belgium are

reforming their stock-markets and launching new futures exchanges.

Amsterdam plans an especially determined attack on SEAQ. It is implementing

a McKinsey report that recommended a screen-based system for wholesale

deals, a special mechanism for big block trades and a bigger market-making

role for brokers.

Ironically, London now finds itself a laggard in some respects. Its

share settlement remains prehistoric; the computerized project to modernize

it has just been scrapped. The SEAQ trading system is falling apart; only

recently has the exchange, belatedly, approves plans draw up by Arthur

Andersen for a replacement, and there is plenty of skepticism in the City

about its ability to deliver. Yet the exchange’s claimed figures for its

share of trading in continental equities suggest that London is holding up

well against its competition.

Are these figures correct? Not necessarily: deals done through an agent

based in London often get counted as SEAQ business even when the

counterpart is based elsewhere and the order has been executed through a

continental bourse. In today’s electronic age, with many firms members of

most European exchanges, the true location of a deal can be impossible to

pin down. Continental bourses claim, anyway, to be winning back business

lost to London.

Financiers in London agree that the glory-days of SEAQ’s international

arm, when other European exchanges were moribund, are gone. Dealing in

London is now more often a complement to, rather than a substitute for,

dealing at home. Big blocks of stock may be bought or sold through London,

but broken apart or assembled through local bourses. Prices tend to be

derived from the domestic exchanges; it is notable that trading on SEAQ

drops when they are closed. Baron van Ittersum, chairman of the Amsterdam

exchange, calls this the “queen’s birthday effect”: trading in Dutch

equities in London slows to a trickle on Dutch public holidays.

Such competition-through-diversity has encourage European exchanges to

cut out the red tape that protected their members from outside competition,

to embrace electronics, and to adapt themselves to the wishes of investors

and issuers. Yet the diversity may also have had a cost in lower liquidity.

Investors, especially from outside Europe, are deterred if liquidity

remains divided among different exchanges. Companies suffer too: they

grumble about the costs of listing on several different markets.

So the third response of Europe’s bourses to their battle has been pan-

European co-operative ventures that could anticipate a bigger European

market. There are more wishful words here than deeds. Work on two joint EC

projects to pool market information, Pipe and Euroquote, was abandoned,

thanks mainly to hostility from Frankfurt and London. Eurolist, under which

a company meeting the listing requirements for one stock exchange will be

entitled to a listing on all, is going forward–but this is hardly a single

market. As Paris’s Mr Theodore puts it, "there is a compelling business

case for the big European exchanges building the European-regulated market

of to-morrow" Sir Andrew Hugh-Smith, chairman of the London exchange has

also long advocated one European market for professional investors

One reason little has been done is that bourses have been coping with

so many reforms at home. Many wanted to push these through before thinking

about Europe. But there is also atavistic nationalism. London, for example,

is unwilling to give up the leading role it has acquired in cross-border

trading between institutions; and other exchanges are unwilling to accept

that it keeps it. Mr. Theodore says there is no future for the European

bourses if they are forced to row in a boat with one helmsman. Amsterdam's

Baron van Ittersum also emphasises that a joint European market must not be

one under London's control.

Hence the latest, lesser notion gripping Europe's exchanges: bilateral

or multilateral links. The futures exchanges have shown the way. Last year

four smaller exchanges led by Amsterdam's EOE and OM, an options exchange

based in Sweden and London, joined together in a federation called FEX In

January of this year the continent's two biggest exchanges, MATIF and the

DTB, announced a link-up that was clearly aimed at toppling London's LIFFE

from its dominant position Gerard Pfauwadel, MATIF's chairman, trumpets the

deal as a precedent for other European exchanges. Mr Breuer, the Deutsche

Borse's chairman, reckons that a network of European exchanges is the way

forward, though he concedes that London will not warm to the idea. The

bourses of France and Germany can be expected to follow the MATIF/DTB lead.

It remains unclear how such link-ups will work, however. The notion is

that members of one exchange should be able to trade products listed on

another. So a Frenchman wanting to buy German government-bond futures could

do so through a dealer on MATIF, even though the contract is actually

traded in Frankfurt. That is easy to arrange via screen-based trading: all

that are needed are local terminals. But linking an electronic market such

as the DTB to a floorbased market with open-outcry trading such as MATIF is

harder Nor have any exchanges thought through an efficient way of pooling

their settlement systems

In any case, linkages and networks will do nothing to reduce the

plethora of European exchanges, or to build a single market for the main

European blue-chip stocks. For that a bigger joint effort is needed It

would not mean the death of national exchanges, for there will always be

business for individual investors, and in securities issued locally Mr

Breuer observes that ultimately all business is local. Small investors will

no doubt go on worrying about currency

risk unless and until monetary union happens. Yet large wholesale

investors are already used to hedging against it. For them, investment in

big European blue-chip securities would be much simpler on a single

wholesale European market, probably subject to a single regulator

More to the point, if investors and issuers want such a market, it will

emerge—whether today's exchanges provide it or not. What, after all, is an

exchange? It is no more than a system to bring together as many buyers and

sellers as possible, preferably under an agreed set of rules. That used to

mean a physically supervised trading floor. But computers have made it

possible to replicate the features of a physical exchange electronically.

And they make the dissemination of prices and the job of applying rules to

a market easier.

Most users of exchanges do not know or care which exchange they are

using: they deal through brokers or dealers. Their concern is to deal with

a reputable firm such as S. G. Warburg, Gold-man Sachs or Deutsche Bank,

not a reputable exchange. Since big firms are now members of most

exchanges, they can choose where to trade and where to resort to off-

exchange deals—which is why there is so much dispute over market shares

within Europe This fluidity creates much scope for new rivals to undercut

established stock exchanges.

6.2 Europe, Meet Electronics

Consider the experience of the New York Stock Exchange, which has

remained stalwartly loyal to its trading floor. It has been losing business

steadily for two decades, even in its own listed stocks. The winners have

included NASDAQ and cheaper regional exchanges. New York's trading has also

migrated to electronic trading systems, such as Jeffries & Co's Posit,

Reuters's Instinct and Wunsch (a computer grandly renamed the Arizona Stock

Exchange).

Something similar may happen in Europe. OM, the Swedish options

exchange, has an electronic trading system it calls Click. It recently

renamed itself the London Securities and Derivatives Exchange. Its chief

executive, Lynton Jones, dreams of offering clients side-by-side on a

screen a choice of cash products, options and futures, some of them

customised to suit particular clients The Chicago futures exchanges,

worried like all established exchanges about losing market share, have

recently launched "flex" contracts that combine the virtues of homogeneous

exchange-traded products with tailor-made over-the-counter ones.

American electronic trading systems are trying to break into European

markets with similarly imaginative products Instinet and Posit are already

active, though they have had limited success so far. NASDAQ has an

international arm in Europe. And there are homegrown systems, too.

Tradepoint, a new electronic order-driver trading system for British

equities, is about to open in London. Even bond-dealers could play a part.

Their trade association, ISMA, is recognized British exchange for trading

in Eurobonds; it has a computerized reporting system known as TRAX; most of

its members use the international clearing-houses Euroclear and Cedel for

trade settlement. It would not be hard for ISMA to widen its scope to

include equities or futures and options. The association has recently

announced a link with the Amsterdam Stock Exchange.

Electronics poses a threat to established exchanges that they will

never meet by trying to go it alone. A single European securities market

(or derivatives market) need not look like an established stock exchange at

all. It could be a network of the diverse trading and settlement systems

that already exists, with the necessary computer terminals scattered across

the EC. It will need to be regulated at the European level to provide

uniform reporting; an audit trail to allow deals to be retraced from seller

to buyer; and a way of making sure that investors can reach the market

makers offering the best prices. Existing national regulators would prefer

to do all this through co-operation; but some financiers already talk of

need for a European SEC. An analogy is European civil aviation’s reluctant

inching towards a European system of air-traffic control.

Once a Europe-wide market with agreed regulation is in place,

competition will window out the winners and losers among the member-

bourses, on the basis of services and cost, or of the rival charms of the

immediacy and size of quote-driven trading set against the keener prices of

order-driven trading. Not a cosy prospect; but if the EC’s existing

exchanges do not submit to such a European framework, other artists will

step in to deny them the adventure.

7. NEW ISSUES

Up to now, we have talked about the function of securities markets as

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