The London and Frankfurt Stock Exchanges

Part of the debate – in the House of Lords at 3:29 pm on 24th May 2000.

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Photo of Lord Lamont of Lerwick Lord Lamont of Lerwick Conservative 3:29 pm, 24th May 2000

rose to call attention to the merging of the London and Frankfurt stock exchanges, and the consequences for companies and investors, including pension funds, if shares have to be denominated in euros; and to move for Papers.

My Lords, I am extremely grateful to have the opportunity to introduce the debate on this important subject although possibly not one with quite the same appeal as the Millennium Dome. I am pleased that the noble Lord, Lord Layard, who has a formidable reputation, is to make his maiden speech. I am sure that I speak for everyone in the House when I say that we look forward very much to hearing his contribution.

I declare an interest as a director of a number of financial companies, all of them listed in the Register of Members' Interests and a number of which are investors or potential investors through the London Stock Exchange. In introducing this subject I hope that I do not have to convince the House that my own interest in the matter is not commercial but relates to the economic and financial importance of the British financial services industry and the London Stock Exchange.

It may well be argued that the proposed merger between the London and Frankfurt stock exchanges is hardly a matter for Parliament because it is not in the hands of government. But if they have decided that they have a watching brief in the negotiations between BMW and Austin Rover, as they quite rightly have, they are then equally justified in keeping an eye on the future of the London Stock Exchange, an institution of enormous importance for our economy.

The proposed merger of the two stock exchanges could be immensely beneficial to London and to the whole of Europe. The vision is a bold one. My speech is intended to be in the nature of a probing one. I am not opposed to the merger; nor, however, am I wholly persuaded of its merits. Much of what I have read leads me to believe that it has been somewhat hastily cobbled together, partly in response to past failures of technology, and also pressures from competitors like NASDAQ. The merger seems to be the classic response of the traditional monopolist to embrace a competitor.

Many of the details are extremely hazy. It is rather ironic that the Stock Exchange should propose a merger without a prospectus and without giving the kinds of detail that it would itself require from a company proposing to list on the exchange. It is very far from being a completed deal. We are not so far down the autobahn that other deals, if they come along, could not be considered. Mr Levitt, the chairman of the United States Securities and Exchange Commission, who might be termed the Alan Greenspan of the securities business, is himself somewhat sceptical and has said:

"Having been an alumnus of six aborted (market) mergers in the US I wonder about how they are going to apply, and the likelihood of, a common listing and common governance structure".

There are a number of worrying points about the terms of the merger. On the German side, iX will have one shareholder with a 50 per cent stake; on the UK side there will be 298 shareholders, each with a 0.17 per cent stake. Looking at those figures, no one would imagine that the London Stock Exchange had seven times the assets of its German counterpart or that there was twice the trading volume in London as in Frankfurt. On the face of it, it does not look like a merger of equals. One is puzzled by the concessions which have been made.

I appreciate that the Deutsche Borse has said that it is going to vote only in accordance with the votes passed by its members rather than using its entire shareholding. Nonetheless the structure sends a strange message. The proposed structure of the growth stocks market with NASDAQ also seems strange with six out of the 12 directorships going to the United States and the rest split between Germany and the United Kingdom.

I agree that the consolidation of stock exchanges throughout Europe may make good sense. It is not satisfactory to have 40 different exchanges serving a single market. When the LSE and the Deutsche Borse come together they could be a formidable force, accounting for 53 per cent of trading in equities in Europe. It is argued that that will reduce costs, spreads and increase liquidity. I shall come to those matters.

But how much do formal exchanges matter? Are they going to be relegated to the scrapheap of history, just like the idea that a building, a trading floor and a lot of shouting jobbers used to constitute an exchange? The real battle is between traditional exchanges, Internet dealing and ECNs, the electronically order-driven networks. Many of the questions that this merger is attempting to answer will be decided, not by officials of the markets, but by the markets themselves. They may well turn out to be very different from those wished on us by the officials of the two exchanges who, incidentally, stand to make huge sums of money out of these proposals.

I turn now to a number of questions of which I have given prior warning to the Minister and on which I hope he will be able to comment. Under the terms of the merger it is intended that the 300 to 500 English and German blue-chip larger companies will be quoted in London. Some people have speculated that this will mean the end of the FTSE 100 and all-share indices. There is nothing terrible about that, although it is important that there should be a credible replacement index because unless there are derivatives attached to those indices one will not get the liquidity in the market that is the whole point of the merger.

While the older, mature companies are to remain quoted in London, the exciting new growth stocks are to be in a new exchange to be set up jointly with NASDAQ in Frankfurt. No company wants to be described as a low growth company, but one wonders what is going to happen to the medium capital stocks, like Babcox. One wonders whether things really will work out precisely in this neat, clear-cut way or whether the markets themselves will decide which stock is quoted in which market.

If the division between Frankfurt and London turns out as planned by the two exchanges, what will that mean for London's initial public offering business? Will it continue in London? What guarantee can there be that when growth companies, the new electronics companies, become the blue-chip companies of tomorrow, they will mysteriously return to London? It is noteworthy that Microsoft in the United States has chosen to continue to remain quoted on NASDAQ. If the new, exciting UK companies of the future are all of necessity driven to Frankfurt, there is a very considerable risk that they will be followed by an exodus of professional firms, advisers and investment banks.

That leads on to the vital question of either the opportunity or the danger, according to one's point of view, of regulatory arbitrage. In the United Kingdom we have a more fully developed and efficient system of regulation than in Germany although it is fair to say that Germany is rapidly improving. Is Daimler Chrysler really going to want to be regulated by the FSA, which is now the London listing authority, and submit itself to all the requirements of the Hampel report on corporate governance and the role of non-executive directors and directors' remuneration? I hope so, but I have my doubts.

At the other extreme, will the new small technology companies be able to side-step UK standards of reporting and accounting by being quoted in Germany? The dangers to investors of the volatility of these so-called exciting companies have been vividly illustrated in the recent past. But if they are to have lower standards of regulation in future, they will lose much of their attraction to UK pension funds and institutions. It is a very great pity that the FSA cannot be the regulatory authority for both exchanges.

There is the question of the transparency of trading in the market. A modern market needs transparency and German trading rules are notoriously opaque. Huge block trades are carried out without reporting and in secret. It seems inevitable from the arrangements put forward that this anti-competitive practice will be extended.

The justification for this deal is economies of scale. But economies of scale do not come about just by putting together two organisations called exchanges. The real economies of scale could come in relation to clearing systems. Eighty per cent of transaction costs occur in back offices and efficiencies come from lower down the curve than from where the trade happens.

A low-cost pan-European equity trading market needs a common settlement system. Yet the proposed arrangements exclude Deutsche Borse's 50 per cent stake in Clearstream and also leave in place the multiple expensive settlement arrangements such as Crest Cedel and Euroclear.

What had been planned in London and, according to newspapers, promoted by the Bank of England was a larger role for the London Clearing House whereby it would have been a central counter-party for all markets and allowed net trading. As the LCH already acts as a central counter-party to the international derivatives business, which flows through LIFFE with all its financial and commodity products, the International Petroleum Exchange and the London Metal Exchange, the City was on the verge of capturing even greater efficiencies. It is not clear whether that has been compromised or just ignored in the deal with Frankfurt. But what is worrying is that Euronext, the merged French, Belgian and Dutch exchange--a competitor to this proposal--has addressed the clearing matter.

Whatever else may be said about this deal, one point, which must be warmly welcomed, seems certain. It must mean the end of stamp duty on shares. If the merger goes ahead, the Chancellor will have no choice in that matter; otherwise share trading will move wholesale to Germany.

The issue of trading platforms is to be tackled, but for many people that will bring tears to their eyes rather than joy. The Sets system, installed only three years ago at such expense, is to be scrapped in favour of the German Xetra. No one, least of all the former Chancellor of the Exchequer, will easily forget the terrible problems that the London Stock Exchange has had in recent years with computerised trading systems.

Both Sets and Xetra were designed by the same firm, Andersen Consulting, so any bugs that are in the two systems are likely to be rather similar. It has been reported that Xetra has been out of action quite a lot in the recent past, including last week. Both systems are old, and faster and more advanced systems are becoming available. This time I hope that the right choice has, at last, been made but yet another change will be extremely expensive for the small brokers, even if it is petty change to the big investment banks. Small brokers are entitled to know how much this will cost and what they will be expected to pay.

One of the suspicions about the merger is that it is driven by the needs of the large investment banks with insufficient regard for retail investors and institutions. No one admires the American investment banks more than I do, but what is good for Goldman Sachs is not necessarily good for a free, open share market. Such concerns have been intensified by the somewhat insensitive handling of the matter of the euro by the stock market. Whatever Mr Cruickshank now says, certainly the Stock Exchange originally intended that all companies should be quoted in euros. Now, I am pleased to say, that the exchange seems to have retreated somewhat from that position.

To compel companies to be quoted in euros, even though Britain continues to stay out of the euro, would be to impose an extra cost, both on the retail investor and on the UK pension funds. The liabilities of the latter are expressed in sterling and they are obliged by law to match their liabilities and assets. The 20 per cent fall in the euro has already translated into a significant fall in pension fund assets, which has to be made up either with the use of derivatives to hedge the risk or from other sources. Obliging companies to quote in euros would add to the risk and add to the cost.

There are strong views on this issue, but surely it is another matter that should be decided by the market. As long as Britain is outside the euro, companies, taking into account the views of investors, should decide in which currency they wish their company shares to be quoted. A modern trading platform should easily be capable of that.

In conclusion, there are many question marks against this merger. It is not clear that the proposals are in the interests of investors. It may be that the competition authorities in Brussels will be able to examine the matter and obtain some of the detailed information that has been missing from the debate. I would be grateful if the Minister would comment on the competence of the Brussels authorities to do that. In the meantime, unless the Stock Exchange stops giving the impression of making things up as it goes along, and until it provides answers to some of the questions asked, I fear that members of the Stock Exchange may well believe that they have ample justification, at least for the moment, for withholding consent from this proposed deal. I beg to move my Motion for Papers.