The London and Frankfurt Stock Exchanges

Part of the debate – in the House of Lords at 4:15 pm on 24th May 2000.

Alert me about debates like this

Photo of Lord Desai Lord Desai Labour 4:15 pm, 24th May 2000

My Lords, first, I thank the noble Lord, Lord Lamont, for introducing this debate. It is timely. I believe that we should discuss this issue way before all the conditions have been settled so we can express the doubts and reservations that we have. That may help those concerned to do a better job.

Secondly, I must warmly welcome my long-time friend and colleague, the noble Lord, Lord Layard. Among his many achievements is that he survived a couple of lectures I gave him on price theory. It does not seem to have done him much harm and he has gone from strength to strength, so he is fairly robust.

I should declare a small interest. I am a non-executive director of a small City firm, Hythe Securities, which trades in Eurobonds. Do not ask me how, but I am a non-executive director of that firm.

In terms of economic theory, mergers are seldom economically efficient. Every time economists study mergers, they find that they give tremendous help to the managers but never help the shareholders and very seldom help the consumers. They are fashionable and all sorts of City firms make a lot of money out of mergers, acquisition business and so on. But seldom can we subscribe to a Darwinian notion that mergers take place for efficiency considerations or because the more efficient firms take over the less efficient ones. Normally, the cash-rich, less efficient firm takes over the rapidly growing, cash-strapped firm. That is very often the case.

In this case that is not a bad analogy because we have a large Stock Exchange--historically, the largest in Europe--merging with a fast-growing exchange. The growth rates of the German Stock Exchange are quite spectacular. Between 1995 and 1998, in terms of new funds raised on the market, the German market doubled every year. While London was nine times Germany in terms of funds raised in 1995, it was only five times by 1998. We can see the way that the growth rate is going.

So there is a great deal of complacency in London and we really must watch it. London tends to regard itself as absolutely the best because it is the largest. The largest markets have to watch and make quite sure that they are as competitive as the small markets coming through. Over the past five years especially there has been a rapid growth of small equity markets all over Europe. They are very innovative markets. Although at present they are small in relation to London, they need to be watched.

One consideration about this merger will be whether the London market can make itself more competitive; in other words, if the merger were to fail, could it actually improve its practices and learn from other markets? Can it survive at the top? Alternatively, if a merger is the solution, it will need the infusion of new blood, new techniques and new practices. It is possible that the establishment of a totally new exchange for iX will prove to be the solution.

Obviously these markets have a physical location only, as it were, by an old-fashioned definition. We can now trade on any market from anywhere. Therefore, as Don Cruickshank said to today's Financial Times, we are talking about frameworks of governance when we talk about London or Frankfurt. These are not just geographical locations. The fact that stocks are being traded on the Frankfurt market does not reduce the number of jobs in London. That is not a relevant consideration. We must consider what kind of efficient combinations can emerge as a result of the merger.

There is also one very important point that we ought to bear in mind. Stock markets are agents only; they are intermediaries. The fact that they have to be efficient is in all our interests. The more efficient they are, the more our savings will come back to us in the form of pensions and so on. So it is in all our interests that markets are efficient and deal in low-cost transactions. I do not care where my pension fund puts its money as long as it gets me a large return. I do not care about the colour of the currency in which it trades or where it puts money: I want my pension fund to give me an income that will keep me happy as and when I retire. Therefore, to that extent, I consider the question of which currency markets trade in to be a purely technical one and of no significance.

We are talking about smart people; they should know how to hedge against exchange rate risks. If they do not, they should not be in the market. They are not ordinary consumers or workers; they are very smart people who trade very fast and who are supposed to know about all the instruments relevant for hedging exchange rate risks. As my noble friend Lord Haskel said, where companies choose to trade, what currencies they want to trade in or how many currencies they want to have are entirely matters for them. It is not of any concern to anyone else.

The one question to ask about this merger is: will it increase efficiency? Right now we do not know. There is insufficient information on hand to consider the question carefully. What we have had are news headlines about growth stocks over there and blue-chip stocks over here, which, when it comes down to it, are basically very cool classifications. One of the reasons behind the merger was the fact that NASDAQ was threatening to come to Europe. Indeed, one thing that such a merger will do is to stave off a separate NASDAQ/Europe and integrate NASDAQ into iX. Therefore, to that extent I believe that it will lead to a richer set of markets.

It is also premature to consider that question because this development may trigger other mergers. No doubt there is a Paris/Amsterdam merger, but there are also the Italian and Portuguese markets which might come on board with German and UK markets. Of course, as has already been said, it remains to be seen. However--this is independent of the merger--the stock exchanges have not proved themselves to be very efficient in the technology that they deploy. Basically, it is quite pathetic that they cannot get a proper computer system designed to do business; indeed, it is very costly to have inefficient machinery. I am surprised that the management concerned is not of sufficiently high quality to sort out such matters. I do not believe that one could afford that kind of inefficiency through technology in any other sphere.

However, we know about trading on Wall Street in the United States. There is so much trade inside the US that 97 per cent of all trades are netted out. They do not really have separate settlements, but that is not yet the case in Europe. There are far too many different markets and one has to settle bilaterally with lots of different markets. The more that markets merge, the more we shall be able to net out. That will lead to a tremendous growth in efficiency. There is one factor that we do know: convergence and integration will lead to cost cutting. For the rest of it, I think that we have to hope that the institutional arrangements that are unveiled, and subsequently the management of the exchanges, are of better quality than what we have had thus far. We must also hope that iX will be able to stand up to the more efficient markets across the Atlantic.

In conclusion, I thank the noble Lord, Lord Lamont, for allowing us to discuss this most important question. It is one to which we shall no doubt return when we know more about the merger. In the meantime, I think we can say, "Well, the jury is out".