It’s happening all over again—exchanges world over are feeling an urge to merge. After the first wave of exchange mergers in 2007, there was a lull for about four years, until in late 2010, Singapore Exchange Ltd (SGX) and Australia’s ASX Ltd said they were in merger talks. And then this month, Deutsche Borse AG (DB) and NYSE Euronext confirmed they were in merger talks, a little after London Stock Exchange Group Plc and Canada’s TMX Group Inc. said they had decided to merge as well.
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There have been reports that other exchanges such as Nasdaq OMX Group Inc., IntercontinentalExchange Inc. and CME Group Inc. could potentially enter the deal-making fray to protect their turf. Even alternative trading venues Bats Global Markets and Chi-X Europe Ltd have decided to come together, making their combine the largest trading venue for European cash equities. Meanwhile Brazil’s BM&FBovespa SA and Shanghai Stock Exchange are expected to sign an agreement that could lead to joint ventures, according to Reuters. In this case, however, a merger is not on the cards.
Even so, it’s evident from the flurry of activity mentioned above that few exchanges want to be left out from the wave of consolidation in the industry. It’s not surprising then that some commentators are ruing the fact that Indian exchanges and their regulators aren’t showing any interest in joining the party. One business newspaper ran the headline “Indian exchanges miss global M&A action”, with the story citing ownership restrictions as the reason for this.
But this view starts with an assumption that exchange mergers are necessarily a good thing. The jury is still out on this. A look at the shares of some exchanges who engaged in M&A activity in 2007 shows that they have underperformed global equity markets since. A recent article by The Economist points out, “The result (of exchange mergers in 2007) for shareholders, predictably, was lousy. Bloomberg’s index of global exchanges remains 42% below its 2007 high (global equities are about one-fifth below their peak). The sales and profits of the big exchanges in rich countries have stagnated since, too.”
This is not to say that all mergers and acquisitions (M&As) in the exchange space is bad; but the opposite view is clearly presumptuous. Marti G. Subrahmanyam, Charles E. Merrill professor of finance and economics at the Stern School of Business at New York University, says, “Some people tend to think that mergers are generally a good thing, and this view is not limited to the exchange space. But ‘bigger is better’ is not a given. In fact, some large global banks such as Citigroup and Bank of America provide a good counter-example. By becoming very large in size through mergers and acquisitions, they became unwieldy and difficult to manage, as was demonstrated during the financial crisis.” He adds that the pertinent question that should be asked before every M&A decision is, “would the whole be greater than the sum of the parts?”
In the case of the DB-NYSE merger, one of the key benefits is said to be the expected annual savings of $400 million, thanks to rationalization of information technology, clearing, market operations and administrative functions. Exchanges in developed markets are facing a double whammy of low growth in trading volumes as well as loss in market share to alternate trading venues. In such an environment, cost savings are critical.
But as Subrahmanyam points out, “Economies of scale are not the major drivers of exchange mergers. Even if the scale of operations was to double after a merger, it’s not that unit costs will go down, although liquidity may improve in some cases. Exchange mergers are more about economies of scope, where one exchange complements the strength of the other. For example, in the DB-NYSE proposal, it could lead to the integration of trading in the cash market with derivatives trading.”
DB has a liquid bund futures contract, which along with NYSE Euronext’s successful gilt futures contracts will be more effective at cornering share of the market for interest rate derivatives from CME Group. The two exchanges will also become a sizable operator in the market for options on US-listed stocks. The merger seems to fit the above-mentioned “economies of scope” criteria.
But not all of the proposed mergers can claim this. And it doesn’t look like there’s much sense for Indian exchanges to go about scouting to partner with a global exchange or an alliance of exchanges. According to Subrahmanyam, “I can’t see much benefit arising for Indian investors from engaging in mergers in the exchange space. By and large, resident Indian investors invest only in Indian stocks, and even though the central bank has permitted investments in stocks listed overseas, investors have barely used this facility. Although investors based in India look outside for news developments that may indirectly affect Indian markets either for fundamental reasons or through FII flows, this doesn’t usually result in investment decisions involving stocks that are listed overseas.”
It’s hard to disagree. Even in developed markets, trading is by and large concentrated on home venues. Long before SGX and ASX decided to merge, they had a developed a trading link, which allowed investors in Singapore to invest in ASX listed stocks and vice versa. They discontinued the facility after a few years because of a lack of investor interest. There don’t seem to be any substantial benefits arising from Indian exchanges merging with others. Benefits such as cross-listing can be achieved even with agreements with other exchanges, without having to go through the exhaustive exercise of a merger. The fact that Indian exchanges can’t participate in the spree of global M&As may be a blessing in disguise, after all.
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