The London and Frankfurt Stock Exchanges

Part of the debate – in the House of Lords at 4:48 pm on 24th May 2000.

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Photo of Lord Blackwell Lord Blackwell Conservative 4:48 pm, 24th May 2000

My Lords, I, too, thank my noble friend Lord Lamont for instigating the debate and for provoking what has so far been a remarkable outbreak of consensus. I shall try to be relatively brief in adding to that consensus.

A common view among noble Lords who have spoken is that the outcome of a merger of this kind will be ultimately determined by the markets, and that the markets will prosper only if they provide an effective and efficient trading system that meets the needs of customers. There are plenty of competitors around who will displace the merged exchange if it does not achieve that position.

There has been widespread acceptance that the principle of global exchanges is now an important one; that there are benefits to be had from liquidity in depth; from the growth in size and scale of exchanges; and from the bringing together of trading that reflects the increasingly international trading portfolios of many investors.

But size of itself is not always the answer. The question is not so much whether the strategy is right but whether, as many noble Lords have said, it will be conducted in a way that is likely to succeed. While that is primarily up to the participants to determine, I would like to add a few observations in view of the importance of this to the wider economy.

I think the most critical question now, in advance of the merger, is whether the two parties can agree terms that will allow the optimum market outcome to emerge unconstrained by political compromises, fudges and woolliness that are likely to cause problems later. The noble Lord, Lord Desai, mentioned that many mergers fail to deliver benefits and I think that research would say that, where mergers fail to deliver, it is often because there are unresolved and unstated objectives and reservations between the two parties. During the courtship they may give different answers to different audiences, and thus fail to get clarity in advance on where they are actually taking the merged organisation. It is particularly important to understand and agree how power will be distributed once the two organisations have come together. The issues of power are often convenient to put aside, ignore or obfuscate, but if the issues of power and control are not understood by everyone, problems can emerge.

One critical area is obviously where the operation, control and wealth creation will lie between the two organisations as they come together. As the noble Lord, Lord Desai, and others have said, we have to remember here that we are not really talking about physical geographical locations in the merger because we are in an environment where electronic trading is leading to vast new developments. Physical location--what is going to be "in Germany" and what is going to be "in the UK"--is much less important in terms of the operation of the exchanges than where the traders, their screens, the users and the customers are located. As we know, that can be anywhere.

That is for the market to determine, but I think most people would expect that the focus of traders and screens will remain in London. There are a number of reasons for that; not least because that is where most of the major institutions are already located. Their resources, systems, infrastructure and their people are there and nothing in the merger itself would prevent that situation from continuing and indeed accelerating. However, for that to happen all the participants must be ready to accept that this will be the outcome should the merger take place. We should not try to build in any artificial barriers, constraints or political inhibitions that could stop the merger happening, because that would cause strains, contradictions and inefficiencies to re-emerge.

The noble Lord, Lord Northbrook, among others, mentioned the importance of the "back office", the settlement and clearing systems. There again, the physical location is much less important because the most critical thing is that the exchanges ultimately end up using the most efficient settlement system that can be put together, whether it is a utility across Europe or a number of local systems. Again, given the evolution of electronic processing--"global straight-through processing" I think is the new term--the physical location will become increasingly irrelevant in the development of the systems. There is nothing per se in the merger that would prevent that happening, so long as vested interests do not try to stop it happening in fixed locations in one place or another.

The other aspect of power that is important, as some other speakers have suggested, is that the power to set the rules lies outside the exchanges themselves. This is an area where we need greater clarity in order to understand what the future of the merger would be. As the noble Lord, Lord Lamont, and others have said, efficient markets clearly need the right balance between, on the one hand, transparency and, on the other hand, the avoidance of undue burdens being placed on the listing companies and the traders. I think it is also important, given the tradition that we have in the United Kingdom, that the markets continue to allow the effective operation of takeover rules and the corporate activity which is important to economic efficiency.

Given all that, I think that the market participants will want reassurance that the volume market, the large stocks, will continue to operate within the successful and open United Kingdom regulatory framework that has evolved and that this will not be distorted by compromises or harmonisations that introduce some of the distortions and the lack of transparency that has perhaps characterised some of the continental exchanges, or that places barriers in the way of takeover activity.

The regulations, as has been said, are equally important for the proposed smaller company exchange, where over-rigid listing rules could block the raising of new capital. If, as is suggested, that is to operate under German regulation initially, then in this country we need to be fully satisfied that such regulation will meet the needs of United Kingdom companies and United Kingdom investors in high-risk and high-tech shares.

We also need to understand, if we can, at this point rather than leaving it until later, what the ultimate objective is, in terms of separate regulation in these two markets: whether the intent would be to bring them together ultimately under some common regulatory framework to allow shares to move from one to the other, and to have some harmonisation. Would it ultimately be acceptable if it proves to be the FSA which provides that control? If the very clear intent is to keep them separate, then we need to understand that this implication is creating two markets which ultimately may well be competitive rather than complementary. Those issues need to be explored rather than left under the carpet.

Finally, alongside regulation another critical power concerns tax policy. My noble friend mentioned that the United Kingdom risks being disadvantaged by stamp duty. One of the powers that may be lost here is the ability to sustain a policy on stamp duty in the United Kingdom which is different from the rest of the Continent. Again, we need to understand whether or not the Government are prepared to accept that implication. All these issues of how power will be exercised and what the implications are need to be addressed in advance of the merger taking place; otherwise, if pushed aside, these difficulties can come back later and unravel the process.

On the subject of currency, as other speakers have said, the Stock Exchange itself has now recognised that attempting to enforce a single currency trading in euros, if that ever was contemplated, is not a valid option. As with other aspects of exchange, it is the needs of customers that will prevail. It is true that many United States investors may prefer to have a single currency across Europe, because to them it is all foreign currency. However, as has also been said, as long as the United Kingdom is outside the euro, it will be important for United Kingdom investors to be able to invest in UK-denominated assets, and they will want to be able to do so. Therefore, at a minimum, it is important to offer choice as to which currency shares are traded in, according to whichever currency the listers choose. It may well be, if this merger goes ahead, that the exchange will have to offer dual currency trading in a number of shares. If it does not, investors will go elsewhere.

To sum up, it is vital to be clear about the execution issues in advance. That means facing the issues as to where power will lie both within the exchanges and in the setting of regulations around them.