Why stock exchanges should be in public hands
If you work for a stock exchange, own shares in one, or operate through one in your daily business, or are below the age of consent, look away and move on – now.
The original function of a stock exchange was to permit the orderly and secure transfer of securities between individuals. One of their key roles is the discovery of the right price through the calling of bids and offers for the securities on their lists. The role remains the same today even if the calls have subsided to the hum of a cooling fan.
Stock exchanges are now huge businesses with the top five totalling over US$130 billion in market capitalisation – yes, they are indeed listed themselves. Because of the fees generated through trading, exchanges have become hugely profitable companies, especially when the Flash Boys’ high-speed computer trading has exploded turnover.
Until now. As profits have soared, the numbers of stock exchanges (and dark pools, the private equivalent run by big bank traders) have mushroomed. There are now 18 stock exchanges in the US alone. Trading values on the London Stock Exchange (LSE) have fallen in recent years despite rising volumes. The LSE’s open exchange market share in FTSE 100 stocks is now 59 per cent, against around 24 per cent for Bats Europe, which only started in 2008.
Old dogs are learning new tricks. The 320-year-old LSE has just commenced a two-minute “intraday auction process” in which orders are entered but not automatically executed. Bargains are briefly matched in the dark in a compromise between liquidity and transparency. The stock exchange hopes that this will compete against the dark pools, where large transactions can take place quietly but at the expense of immediate transparency.
The announcement last week of a proposed merger between Deutsche Bourse and the London Stock Exchange highlights the battle. Their first attempt by the Germans to buy the venerable LSE was in 2000, when a bid for US$1.1 billion was foiled. They returned in 2004 with a rejected bid of US$1.8 billion, but their stalking was finally rewarded last week for a US$14.5 billion cheque. Not a bad return; and rival predators like Intercontinental Exchange (owner of the NYSE), and the largest, the CME Group are still circling.
Could the Hong Kong Stock Exchange, now a measly fourth largest in the world with a market cap of US$28 billion, be left behind? The Shanghai-Hong Kong connect was a most positive move to ease cross-border trading but it now looks positively domestic. Yet the HKEx could be the next target because our time zone is very attractive; it is not London or New York. It may be cute to play hard to get – but the future is clear; the HKEx will either compete within a global group, or be competed against.
For this great game of Stock Exchange Monopoly is inevitably going to end up with just a few exchanges; and they will be providing 24/5¾ trading. In theory, one mega exchange would continually trade global titans, like Apple, Daimler Benz, GE, HSBC, and Royal Dutch Shell. One exchange could trade and provide a clearing house for derivatives, and one would be required for commodities. There will still be an important role for regional or national exchanges to cover local stocks – if the HKEx wants to be a bit player.
But when the next big market crash comes, as always, it will be centred on the exchanges’ ability to provide liquidity. Firms dealing in a crisis are often unable to make prices, inhibiting price discovery – and causing accelerated distress. The only clear way around this is for governments to appreciate that they are always the lender of last resort. Part of the future management of these global stock markets will be the effectiveness of the multilateral government backstop that, in times of crisis, will called upon to provide the liquidity that private participants cannot or will not. For, liquidity is the Achilles’ Heel of the global economy.
As stock exchanges merge into global behemoths, they are already too important to the health of the global economy to be commercial playthings. Indeed, it cannot be long before exchanges have to surrender to the conflict of interest whereby they both make and enforce trading rules, and become regulated like any other security house.
This means that stock exchanges will become much more like utilities. They provide a public service and will be regulated as such. I hate to sound like a pinko – but stock exchanges are now so important to the health of the global economy that perhaps they should be run like a public asset.
Richard Harris is chief executive of Port Shelter Investment Management