Competition and Integration of Stock Exchanges

contest and integrating of farm animal put backs synopsisThe increase in competition of logical argument interchanges, due mainly to the novelty of the securities grocery stores, has led to mergers, technological agreements among existing mass meetings, slew wars, takeovers, and the creation of youngborn deputizes, fifty-fifty inside the same country. Recently, exchanges ca-ca as well faced competition from quasi-exchanges, which be withal k at presentn as ECNs. They non only free-ride on the functioning of itemisation presumptuousness that they gener bothy workmanship only securities bring uped on another(prenominal)(a) exchanges, only similarly on the bell-discovery process facilitating extremitys of exchanges to withdraw distribute to them. ECNs be increasingly ejectnibalizing the businesses of the existing breed exchanges.The evolution of new pecuniary instruments, the locomote monopoly of banks as a source of direct funding to borrowers and of direct coronation for investors, the tremendous improvement in study technology, and a great fiscal culture among common people as well as the fluctuations in interest, cost, and exchange rate due to the oil crises nourish caused the increasing wideness of securities markets in the financial body.As the capital markets be light increasingly globalized, investors pass water more choices and ar demanding violate barter facilities, market efficiency and timber from beginning exchanges. To meet gainsays, exchanges look at to accelerate the construction of the market selective in hurlation infra social system, rivalry among atomic number 63s simple eye exchanges emphasizes more on cooperation of job technology than anything else. In Asia, the design of forming a full financial service group within each market is the main consideration. transfers have recognized that faced with the challenge to respond mercenaryly to competitors, they needed to become raftd comp anies themselves.The underlying assumption is that, in the long run, only the most efficient exchanges should survive, calling stocks from other europiuman countries and offering the most innovative and competitive financial instruments.Table of limit (Jump to)I Abstract.. 2II List of Abbreviations. 51. Introduction 6-112. examine of Literature2.1 What is an supersede. 12-162.2 Globalisation of Financial Markets 17-202.3 Nature of Competition of sprout diversifys.. 20-242.4 The effectuates of Increasing Competition among roue deputizes. 24-252.5 Revolutionary changes of Technology in the Securities Market.. 26-292.6 Integration of storage Exchanges 29-302.7 Theoretical Influences 31-373. Methodology3.1 Aim of the Project. 383.2 Objectives of the Project 383.3 Why I am Interested in this Topic. 393.4 terra firma 39-403.5 The General Approach.. 40-413.6 Data Collection.. 41-433.7 Criticisms of the Sources 43-443.8 Validity.. 443.9 Reliability.. 44-454. Qualitative Analy sis4.1 Analysis of patience Dynamics. 46-56Case Studies4.2.1 International Exchange- LSE- A Prototype of Horizontal Merger 57-614.2.2 Hong Kong armory Exchange A Typical Model of a Vertical Merger. 62-664.3 Implications and Discussion.. 66-695.0 Conclusion70-72Appendices accessory 1 Interviewees Questions74Appendix 2 Interview Key Points.. 75-77Appendix 3 Future Strategies of LSE HKSE. 78-80Bibliography 81-87List of AbbreviationsECNs Electronic Communication NetworksISD enthronisation Service leadingEU European UnioniX International ExchangeLSE capital of the United Kingdom Stock ExchangeDB Deutsche BorseNYSE New York Stock ExchangePSE Philippine Stock ExchangePB Paris BorseSGX Singapore ExchangeTSE Tokyo Stock ExchangeSEC Securities and Exchange CommissionCCASS The exchange Clearing and Settlement SystemHKFE Hong Kong Futures ExchangeHKSCC Hong Kong Securities Clearing Company special(a)1. IntroductionThere argon currently whatsoeverwhat 250 institutions recognized as exchanges in the world, and two item-by-itemly and collectively they play a captious role in most national economies and also at a global level. They provide cash, futures, options and other forms of derivatives, markets for all major commodities and assets craftd in the world.Competition among stock exchanges, two national and international, is a late phenomenon. Until approximately decades ago, it was intemperate to think of exchanges as firms that produce and sell goods to customers and compete among themselves. Traditionally, exchanges were seen either as unrestricted entities or as formally private bodies, deeply regulate by public rules. In both cases, they were often legal monopolist, tending(p) the special nature of their legal action that very much resembled that of a public good.There was an era when exchanges were natural monopolies (Steil, 1996b), yet nowadays they no long-life enjoy a monopoly in the provision of many of their go. When its genus Phalluss owned a monopolistic exchange, it did not have the incentive to maximise its profits because members in charge were prohibited from taking any distribution of profits from the exchange. Exchanges increasingly realize that if they have to compete like firms whose goal is to maximize sh atomic number 18holders wealth, they have to demutualise to turn a member-owned company into a stock company. Exchanges have neer been considered as firms, but now they have reformed to become commercially driven corporations. To understand the firms view of an exchange, it is necessary to redefine what an exchange is, what its products ar, where its revenues come from and who its customers and suppliers atomic number 18. Exchanges ar special kinds of firms that provide listing, vocation and price dissemination services. calculate customers involve listed companies and those, which desire to go public, entropy suppliers and intermediaries that trade on the exchange. Intermediaries trade on b ehalf of both individual and institutional clients who are substantiative customers of an exchange.Suppliers are net income providers. Listed companies have a dual capacity as suppliers of information and shares for trading.The primary objective of this discourse is to analyse the competition and integration strategies of stock exchanges like firms.The dissertation focuses on1. Industry dynamics of stock exchanges2. ontogeny of stock exchange mergers3. Integration strategies and4. Future integrating trends.Advances in technology have further accelerated the globalization trend. In particular away access to trading systems, implying that the services offered by stock exchanges sens now be accessed from anywhere, including firms having their stocks traded on international exchanges while still being tardily accessible to local investors. This type of arrangement is likely to develop a competitive environment, where the most efficient exchanges will eventually win the trustin gness of investors, traders and companies (Cybo-Ott peerless, Di Noia and Murgia 2000). The structure of the European stock-exchange environment is changing rapidly. Almost every day, in that respect are new alliances between stock exchanges, stock exchange privatizations, lucre exchanges and electronic exchanges, as well as online brokers, etc. appear in the media. The changes are driven primarily by intensified competition, which is related to the deregulating of stock exchanges, technological progress and the increasing internationalization of the securities markets.Competition takes the form of existing exchanges and electronic communication meshings (ECNs).The increase in competition of stock exchanges, due mainly to the transformation of the securities markets, has led to mergers, technological agreements among existing exchanges, price wars, takeovers, and the creation of new exchanges, even within the same country. Recently, exchanges have also faced competition from qua si-exchanges, which are also known as ECNs. They are parasites on stock exchanges. They not only free-ride on the process of listing given that they generally trade only securities listed on other exchanges, but also on the price-discovery process facilitating members of exchanges to direct trade to them. ECNs are increasingly sewernibalizing the businesses of the existing stock exchanges.Mergers have been unity of the most probable strategic interactions among stock exchanges. The concept presented here is drawn upon the network externality literature. Exchanges raise be regarded as networks in which an increase in the size of the network leads to an exp iodinntial increase in the networks value (Shapiro Varian, 1999). In other words, bigger networks are more attractive to users than smaller ones. Castells (2000) links a network to its connectedness and consistency. When firms decide on a listing exchange, they choose the one that is connected by the largest number of intermedi aries and one that consistently provides the greatest liquidness.In Europe, the pressure for consolidation among stock exchanges has been the arrival of the euro. The full implementation of the Investment Service Directive 1992 (ISD), which allows its members to gain conflicting access by means ofout the European Union (EU), further facilitates the financial market integration in the region. The European Securities Forum is promoting the model of horizontal merger. In this model, national exchanges desegregate along three functional levels trading, illumination and cloture, and custody. Each market participant can gain access to a range of pan-European services done a single point of debut.The proposed formation of International Exchange (iX) from capital of the United Kingdom Stock Exchange (LSE) and Deutsche Brse (DB) and the recent establishment of Euronext (the merged entity among the exchanges of Paris, Amsterdam and Brussels) are outcomes of this model.An analytical fr amework will be provided to analyze industry dynamics and integration strategies. The models used embarrass Porters Five Forces Model, Network Society and Ansoffs Product-Market Matrix. These models are utilized to explain how exchanges determined their merger motives and developed integration and consolidation strategies.Given the rapidly evolving nature of the industry, a total of 5 interrogates were conducted with members of the London Stock Exchange and Hong Kong Stock Exchange, investment banks/brokerage firms. Primary info sources were home plated on the interviews. Secondary data sources embarrassd academic journals, books, newspapers and work papers. The deliverable is this report, which includes the literature review, findings and discussions, and two case studies.The implementation followed a tralatitious approach project specification, literature re seek, fact finding and investigation, case psychoanalysis and evaluation, and finally, report writing.The first fin ding from the interviews is that merger is a clear strategic option for exchanges. This strategy can achieve economies of scale, network externalities, improve profitableness and enhance efficiency in the decision-making process and arrange routing facilities. In particular, a cross-border merger between two exchanges is make possible in Europe with the support of the financial markets harmonization.The second finding is that a merger brings about two patterns of convergence vertical merger and horizontal merger.The former depicts that exchanges integrate to form a full financial service group offering the trades of a wide variety of financial products such(prenominal) as stocks, options, futures and other derivative products. The latter describes the merger of specialized exchanges, the outcome of which creates compatibility, a concept in that intermediaries trading in one exchange are offered remote access in other member states, with reciprocity and without further requirement s.The 3rd finding is that the existence of national regulatory regimes, deeply embedded in their corresponding regulators, constrains further inter-exchange alliance or merger. The ultimate goal to have a supranational regulator that imposes its own hackneyeds on the globe is incredible to happen in the near future.The fourth finding is that the single price and time priority is not an issue in an order-driven market such as Hong Kong Stock Exchange and the London Stock Exchange. In contrast, in a quote-driven mechanism such as Nasdaq, each market shaping machine is itself an execution centre though operating within certain parameters set by the National Association of Securities Dealers (USA). In quote driven or hybrid environments, there creates space for the development of ECNs. The growth of ECNs is gradually arduous to replace quote-driven trading systems.The fifth finding forms an interesting consensus regarding the motives of investors who choose to trade on an ECN. Inve stors are not able to differentiate the functionalities of a trading system of stock exchange and that of an ECN as long as they can function their orders at the best possible price. Competition only on price is inadequate for an ECNs survival. They lack the competencies in attracting liquidity and information dissemination.This dissertation is organised as followsSection 1 defines an exchange as a firmSection 2 analyses the existing competition and integration of stock exchanges in Asia and in EuropeSection 3 uses Porters Five Forces and network externalities to shape the industry dynamics then it utilizes Ansoffs Product-Market Matrix to determine the strategic choice of a stock exchangeSection 4 presents the interview framework and cites opinions to analyse the two case studies London Stock Exchange and the Hong Kong Stock exchange andSection 5 further develops the findings and links them with the metaphysical framework and literature review.2. Review of the Literature2.1 What is an Exchange?A stock exchange has two principal functions. The first is the listing of securities. The stock exchange must(prenominal) approve prospectuses for the eligible securities and also administer the statutory information obligations imposed on the issuers. Secondly, the stock exchange is a marketplace for its members to trade the listed securities. Previously, the brokers gathered physically on the floor where the price was fixed by auction. Today, most stock exchanges have introduced electronic trading systems in some form or other, so it is no longer necessary for the brokers to be physically present at the stock exchange.Stock exchanges can be seen as a market, not too much different from the one that fruits and vegetables are traded on. They operate according to the laws of supply and demand and the most successful, whilst having tenable regulation, will be constantly changing and developing their market trading operations. Domowitz has given a comprehensive defini tion, stating An exchange is a trading system that mustProvide trade execution facilitiesProvide price information in the form of buy and sell quotations on a regular or continuous basisEngage in price discovery through its trading procedures, rules or mechanismsHave either a formal market-maker structure or a consolidated limit order book or be a single price auctionCentralize trading for the purpose of trade executionHave membersExhibit the likelihood, through system rules and/or design, of creating liquidity in the sense that there be entry of buy and sell quotations on a regular basis, such that both buyers and sellers have a reasonable expectation that they can regularly execute their orders at these quotesAn exchange is generally described by regulatory government activity as an organization, association, or group of persons that provides a marketplace for exchanging securities between purchasers and sellers. Traditionally, an exchange is owned by members who are also interm ediaries. Under a member ownership structure, members did not have the incentive to invest in the exchange infrastructure including technology and trading facilities because returns from these investments could not be distributed to them. The lack of pauperization undermined the profitability of an exchange and hence its competitiveness. In addition, intermediaries trading on a monopolistic exchange were subject to higher prices.They passed the increased costs of operations onto their customers. Therefore members were reluctant to vote for an increase in transaction levy. Hansmann (1980) notes thatThe nonprofit organization maker, like its for-profit reverberationpart, has the capacity to raise priceswithout much fear of customer reprisal still it lacks the incentive to do so because those in charge are bar from taking home any resulting profits.As time has gone by, exchanges have had to compete in the global market to attract quality companies to list and intermediaries to tr ade many of them have converted their member ownership structures into a stock company by means of demutualisation. Under the plan of demutualisation, members are issued shares of the exchange. They become shareholders of the exchange and therefore can be eligible for profit distribution. Since then, exchanges have reformed to become commercially driven corporations whose goal is to maximize shareholders wealth.2.1.1 ProductsStock exchanges cannot only be perceived by the function they busy in an economy, they can also be viewed as a firm, producing a product. The product is the creation of a market in financial instruments, gum olibanum leaving the property of the price information produced with the stock exchange. More specifically the products a stock exchange offers encompass listing, trading, price-information services and clearing resolving, the piece of which are shown in Table 1. The distribution of revenues from these various offerings shows that the focus lies loosel y on listing and trading, as other services are not always part of the offering.Table 1Fees Europe % N. America % leaning 19.3 32.1Trading 45.1 39.7Services 24.4 22.6 separate 11.2 5.7The firm view focuses on the business and profitability of an exchange. Mulherin etalii (1991) defines a financial exchange not as a market, as it normally is, but as a firm that creates a market which is characterized by the use of financial vehicles.Lee (1998) suggests that a earnest market be regarded as a firm that produces goods listing, trading of securities, clearing and colonization services, price information dissemination, and research. In this dissertation, the aspect of the provision of settlement services is omitted because many of the exchanges either dismiss it or do it by a separate entity.The dissertation considers the exchange as a producer of listing and trading services, given that the network externalities effects created by listed companies and intermediaries are the main focus .2.1.2 RevenuesThe revenues from listing and trading are in general fees, both initial and annual. Services include Settlement Clearing and price-information services. Thus the trading services offered by a stock exchange can be structured in three parts the object traded (issued by some entities that generally pay a fee to have it listed), the means of trading (trading facilities, computers, a computerized floor, settlement) and price dissemination.The listing and trading and related services can be segregated and tagged as the front-end of stock exchanges. Clearing and settlement is the unglamorous bit after equities or bonds are traded on an exchange. A clearing house ensures that buyer and seller have the cash and securities to do the deal a securities depository settles the trade by moving the securities from one answer for to another.The profitability of an exchange establishes the extent to how successful it is in attracting order flow and in attaining the ability to genera te revenues (Lee, 1998). Order flow implies the liquidity of the market and the trading volume that includes the number of trades over a condition period and the total value of the shares traded. It directly and indirectly generates revenues for an exchange. The direct effect comes from an exchanges receipts for transaction services, which are dependent on the number of trades it executes. The indirect effect exists because the trading volume reported on an exchange is regularly used as a marketing tool to attract new listings to the exchange.2.1.3 CustomersAn exchange has direct and indirect customersDirect customers include listed companies and those which desire to go public both pay for their use of listing services. They also include intermediaries who pay to be admitted to trading and information providers who pay to have death access and the right to disseminate price information.Indirect customers are individual and institutional entities that send orders to intermediaries for execution on an exchange. They can either trade through an intermediary or via the Internet. In both cases, they take into account the quality of the exchange, price factors and transaction cost. Market microstructure, such as liquidity, price discovery, or immediacy, and reputation and fiscal regulation all influence their choices. Other income includes share registration service fee income arising from initial public offerings.2.1.4 SuppliersListed companies are also suppliers because they provide the information and the shares for trading. Another type of suppliers is the network provider who provides physical connectivity services on an exchange infrastructure.The above describes an exchange as a firm globalization of financial markets and competition of exchanges have caused the convert of an exchange from a market to a firm.2.2 Globalisation of Financial MarketsSince 1980, cross-border securities legal proceeding have grown very rapidly. A quarter of stock market trades worldwide involved either a foreign security or a foreign counterparty by 1988 (Howells and Bain, 2000). Between 1989 and 1995, estimated global turnover in foreign exchange more than doubled.With the formation of the European Union, cross-border trading in Europe is growing in popularity. The introduction of the euro and a wider acceptance of fair play as a financing tool are encouraging investors in Europe to engage in more cross-border transactions in search of profit-making opportunities. Yet despite the appeal of cross-border trading, most stock exchanges in Europe are national institutions that trade only local, country-specific stocks.This market structure appears to be changing, however, as an increasing number of stock exchanges are attempting to operate across national borders. A Transaction Survey done by Hong Kong Stock Exchange in 2000 indicated that overseas investors (mainly institutions) had significantly increased their participation in the Hong Kong market. In E urope several ambitious initiatives have been undertaken of late to create, through mergers or other consolidations, pan-European exchanges that offer trading in stocks from many European countries. The establishment of these exchanges will likely lead to important benefits for the financial markets. For example, a standardization of trading platforms across exchanges, an increase in market liquidity, and a reduction in market fragmentation potential by-products of consolidationcould help calumniate the costs and problems associated with cross-border trading in Europe.Despite the persistence of protectionism and restrictions to free trade, markets for goods and services are becoming increasingly globalized (Castells, 1996). Financial institutions are extending their activities either by developing new products or by penetrating new markets in response to growing competition. They are also widening their customer base to benefit from economies of scale and scope.Expansion occurs bot h within national boundaries, and also across borders to establish presence in international markets. Globalization of markets has been made possible in the late twentieth century by new communication and transportation technologies allowing for more efficient delivery of information, goods and services.2.2.1 Europe stack to Become a Pan-European Financial MarketThe concept of harmonization of financial regulations to establish a single financial market across the EU was brought out since the 1957 Treaty of Rome when it established the European Economic society (EC) (Howells and Bain, 2000). Extensive liberalization of financial markets was seen in the 1960s regarding direct investments, commercial credits and the acquisition of securities on foreign stock exchanges.A genuine single financial market across the EU extended to include the securities markets and the insurance services industry. In 1979, the Directive Co-ordinating the Conditions for the Admission of Securities to Of ficial Stock Exchange Listing allowed companies to list their shares or raise capital on other EU stock exchanges. The ISD, based on the Single European Act principles, applied the single passport principle to non-bank investment firms, removing barriers to both provision of cross-border securities services and the establishment of branches throughout the EU for all firms. It also liberalized the rules governing access to stock exchanges, and financial futures and options exchanges. Mutual recognition and home-country jibe for all security firms and banks performing investment services were shared among all member states.As with other financial services, the insurance industry proverb the promulgation of certain directives all established the right for companies to operate in other member states.The Euro launch as a common cash on 1 January 1999 by 11 European nations has been considered a bill toward Europes economic convergence. Euro facilitates to establish shared, centralize d accounting and administrative systems dramatically chasten currency exchange costs and increase price transparency for the member countries. Even non-members dealing with member countries may also benefit from greater price transparency when dealing with one, rather than a number of different, currencies (Geradine, 2000).As discussed above, globalization has become a major driver of change, which was confirmed by rapid growth in cross-border portfolio investment and cooperation of markets2.2.2 Asia Evolution of Strategic Alliances and CooperationAsia peaceable saw the frantic pace of exchange alliances and cooperative arrangements.Most recent examples includeOn 1 February 2000, HKSE jointly agreed with Nasdaq to launch the NASDAQ curbing Pilot Programme for the trading of seven global securities (Amgen, Applied Materials, lake herring Systems, Dell, Intel, Microsoft and Starbucks) in Hong Kong. These shares can be traded and settled in Hong Kong dollars following the standard T+ 2 (the second trading day following the transaction) settlement period.Memorandum of Understanding among various countries were signed to facilitate information sharing and cooperation of regulatory matters examples are Jakarta Stock Exchange and the Amsterdam Exchange The Singapore Exchange and the Australian Stock Exchange The Stock Exchange of Thailand and the Tokyo Stock Exchange.In Japan, The Osaka Securities Exchange signed a furrow Cooperation Agreement with Nasdaq Japan Inc. to establish the Nasdaq Japan for acceptance of listing applications on the Nasdaq-Japan market. Another collaboration accord was signed between The Tokyo Stock Exchange and the Korea Stock Exchange for the effective management of their operations and better investor protection, which allowed for useful information swap regarding promotion of stock investment and oversight of market activities.2.3 Nature of Competition of Stock ExchangesThe evolution of new financial instruments, the falling monopoly of banks as a source of direct funding to borrowers and of direct investment for investors, the tremendous improvement in information technology, and a greater financial culture among people as well as the fluctuations in interest, price, and exchange rate due to the oil crises have caused the increasing grandeur of securities markets in the financial system, both as regulated exchanges and over the counter (OECD, 1996). New theories of financial intermediation (Allen and Santomero, 1996 Allen and Gale, 1997) underline the importance of the markets in such a way that all intermediaries (banks, mutual funds, etc.) perform a risk-management activity in between borrowers and lenders on one side and markets on the other, providing a kind of risk insurance. In spite of that, banks and markets can still coexist (Boot and Thakor, 1997).Th