Streetwise Professor

May 20, 2006

What She Said

Filed under: Exchanges — The Professor @ 1:36 am

The IHT and NYT ran a very sensible article on the “bourse merger stampede” by Jenny Anderson (with contributions from Heather Timmons). Anderson, and the people she quotes, express considerable skepticism over the economics of exchange mergers, especially cross-border mergers. Anderson says: “[w]hile the Big Board and Nasdaq are excited about global consolidation, neither has made an effective case for how to accomplish such a merger and what it offers, beyond diversification.” Here, here!

Anderson states that Nasdaq’s CEO, Robert Greifeld, believes that a merger with the LSE would allow creation of a single system with lower costs. Where are these savings to come from? LSE and Nasdaq already have trading platforms up and running. Is one going to replace the other? If so, there will be some significant costs to be incurred upfront by the exchange whose system is replaced, and perhaps more importantly, by its customers. There will be savings in development costs down the line, but it is by no means clear how big these savings will be. Moreover, there will be other costs. Furthermore, and perhaps most important, cultural and regulatory differences may make a Nasdaq-LSE tie up very expensive and cumbersome.

As for a combination of NYSE and a European exchange (with Euronext being the likeliest candidate at this round of speed dating), the most commonly cited benefit is “diversification.” Run, don’t walk, away as quickly as possible when managers justify a merger through its diversification benefits. That’s what equity markets are for–to allow investors to diversify so that firms don’t have to do it through acquisition. Moreover, it is arguable whether a purchase of a European stock and derivatives exchange really generates much diversification. The correlation between trading volumes across equity markets is pretty high. And there are downsides to geographic and product line diversification, most notably the cultural and regulatory factors alluded to earlier.

Several hedge funds, most notably Winchfield Holdings are hot for Euronext to merge with DB. This suggests that they see some cost savings, and indeed this may be the case for an intra-European combination. Next week’s non-binding Euronext shareholder vote on this merger will provide some indication of whether this is a commonly held view.

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