The London and Frankfurt Stock Exchanges

Part of the debate – in the House of Lords at 3:55 pm on 24th May 2000.

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Photo of Lord Northbrook Lord Northbrook Conservative 3:55 pm, 24th May 2000

My Lords, I am sure that the whole House would wish to join me in congratulating the noble Lord, Lord Layard, on his excellent maiden speech. The noble Lord is one of Britain's leading applied economists and has created, at the Centre for Economic Performance, one of the world's top economic research centres. Through his researches, he laid the intellectual foundations for welfare to work, and he promoted those ideas most effectively by founding the Employment Policy Institute. We look forward with interest to his useful, thoughtful contributions.

First, I declare an interest as a director of a fund management company based in London. Therefore, I speak with some experience of using the London Stock Exchange. In my short contribution, I wish to focus on the practicalities of the proposed merger between the London Stock Exchange and the Deutsche Borse. It is far too often claimed that the investment management and stockbroking firms which act for individual investors are always against change. Just like anyone else in finance, they recognise the need for these necessary changes and plan for them. Strategically, the alliance between the London Stock Exchange and the Deutsche Borse is a good one. Companies which seek to offer their goods and services outside their own geographic borders often most successfully do so by acquisitions and mergers, especially as competition becomes fiercer. A combination of NASDAQ Europe, electronic crossing networks, to which my noble friend Lord Lamont referred, JIWAY and persistent rumours about tradepoint, means that the choice strategically for the London Stock Exchange appears to be either alliance or decline.

Five markets are effectively formed by iX. The first is the blue chip market, which will take Europe's top 300 to 500 companies and will trade in either sterling or euros, depending on the company and its primary trading currency. The second is a high growth market for technology companies, which will be formed on a 50:50 basis between NASDAQ Europe and iX. These stocks are expected to trade in euros. UK and German companies that do not qualify for either the blue chip or high growth markets will continue to trade on their own local exchanges. In addition, the AIM market will continue as before.

I deal now with my general areas of concern about the merger. I agree with the Shadow Chancellor that stamp duty disparities, regulatory problems and the aim of doing all trading in euros are major problems, especially for the private investor. I also wish to concentrate on a few specific problems of detail from a practitioner's viewpoint. First, there is the problem of the high technology area of iX. The high technology companies will come from the Frankfurt Neuer Markt, the London Stock Exchange's Techmark stocks, excluding the upper tier, blue chip ones, and from NASDAQ. These stocks are expected to trade in euros. We are faced with a situation where a quoted London technology stock outside the top 300 to 500 European top companies will find that it not only may see the currency of its share price change but also that it will be regulated by the German regulator. Such a change may discourage technology companies from coming to the market and will also create problems if they move from one level to another. UK investors may also be deterred from investing in them with a euro share price. Also, there may well be extra custody costs in holding the share.

Going on to more detailed concerns, there are two main administrative areas where major upheaval will occur as a result of the merger. The first area is trading platforms. The market for blue chip stocks will be regulated in the UK but will abandon the SETS system, to be replaced by its German cousin, Xetra. While the Stock Exchange system fails from time to time (the most notable occasion being 5th April this year for almost the whole day), Xetra fails too, and more often. Thus there will be one set of costs to change to Xetra from SETS then a second and much bigger cost to rebuild the whole entity to give, as the exchange press release said,

"a Common Market model and regulatory approach", offering trading in all UK equities. Some have estimated the cost of the first change to be at least £500,000 per firm and the second step--the major rebuild--to be many more times that.

The settlement situation for stocks is also undecided. Crest, the UK system, is a European leader in terms of the capability of its market systems and its multi-currency facility. Its lead is further emphasised by the need for the Deutsche Borse clearing system to be rationalised as it will be merging with Cedel to form Clearstream. If Clearstream were to be adopted as the settlement system, then the costs to all brokers and investment houses in the UK would be significantly greater than the costs associated with changing the trading platform.

My next area of concern is that of a central counterparty. Neither the Deutsche Borse nor the London Stock Exchange has one. However Eurex (the European Futures and Options Exchange) does, and it is part of the deal. Work is also underway with the London Clearing House to create a central counterparty for SETS. The proposition is that the UK will continue to build the central counterparty. It is then to be linked to Euronext (the French, Dutch and Belgian Exchanges proposed merger) followed by a third set of changes to create a central counterparty for the entire merger. The UK Stock Exchange, in its recent press release, states,

"It is intended that trading on the unified Pan-European market will ultimately feed one central counterparty".

Who will pay for that? And is it to be in the UK or Germany? Those matters need to be clarified by the London Stock Exchange in its forthcoming information memorandum.

My next area of concern is the regulation of the merged markets. The "big five" brokers expressed the following concerns about the regulation of the merged stock markets. They believe that, while it is not practical to have a single unified market for all equity securities, given different liquidity characteristics, it is essential to have a single regulatory system which is transparent and flexible. They believe that this also needs one set of listing requirements and trading rules with fully transparent trading so professionals can see both what securities are changing hands and at what price. They believe, as my noble friend Lord Lamont stated, that German rules are notoriously opaque and less demanding than the FSA. Brokers can carry out huge block trades in secret. Frankfurt listing rules are also unnecessarily complicated. The brokers believe it is surprising that the FSA, which has taken over from the Stock Exchange as the UK listing authority, has not made that point where it is overwhelmingly best placed to be iX's regulator as well as the single listing authority.

Current shareholders in the Stock Exchange will ultimately decide its future at the forthcoming EGM. Well before that EGM is reached, more answers on how this alliance is going to work need to be given. To get that right, first, the exchange needs to publish details of the changes as soon as possible, including costs, outcomes and alternatives, and let the market users decide the most appropriate solution. It should be one which is relevant to all sectors and not preferentially weighted against any. Secondly, iX should take responsibility for at least some of the changeover costs of the users. Thirdly, continuous consultation should take place which actively responds to concerns.

Not only the institutions should be consulted, but the private investor must not be excluded, especially at a time when the Government are urging people into ISAs, employee share schemes and stakeholder pensions. In the first three months of this year, more than 6 million bargains were traded for the private investor. That is not a small number and therefore the brokers and fund managers who look after them must be consulted too.