Romancing the stone…

Published by: The WFE Focus Team Nov 2016

Peter Lenardos, Managing Director, RBC Capital Markets reviews the key themes to emerge from the Exchange Consolidation panel session he took part in during the 56th WFE General Assembly & Annual Meeting.

From 2 to 4 November, I attended the World Federation of Exchanges’ 56th Annual Assembly in Cartagena, Colombia (hence the title of this column, referring to the movie classic with Michael Douglas and Kathleen Turner).

In attendance were the most senior executives from exchange groups, trading firms and technology companies globally, in addition to high-ranking officials from the World Bank, Government of Colombia, European Parliament, HM Treasury, IOSCO and the US Federal Reserve, among others.

I participated in a discussion entitled ‘Consolidation: Time to Catch the Wave Again?’ which addressed why consolidation is so compelling for financial market infrastructure providers. Alongside me on the panel were: Caroline Silver, Moelis & Company, Roberto Belchior, MN&FBOVESPA, Hans Sicat, Philippine Stock Exchange, with moderator Massimo Capuano, IW Bank.

The topic of consolidation is especially relevant given the high profile and pending deals in the sector, including CBOE’s acquisition of Bats Global Markets, and the merger of equals between Deutsche Boerse and the London Stock Exchange Group.

I believe that exchange group M&A has been so prevalent and remains ongoing because of the advantages it offers.

These advantages can be summed up as the ‘3 S’s’: Scale (larger organisations typically operate more efficiently and serve a client’s desire to work with fewer partners); Synergies (cost savings); and Standardisation (of trading platforms, which eliminates the need for redundant systems and is more user friendly to users of exchanges).

In addition, I derived an acronym - DOM CAGR - to explain the remaining benefits of and reasons for financial market infrastructure consolidation:

  • Diversify by product and geography, and away from hyper competitive cash markets.
  • Optimise client collateral (especially as mandatory central clearing gets phased in and expands to other asset classes and regions).
  • Macroeconomic outlook: organic growth is difficult given near-zero interest rates, low volatility, subdued economic growth and uncertain global events; the outlook could negatively impact trading activity, new listings, capital raising, asset-based fees and demand for market data.
  • Competition remains intense and will continue to intensify; M&A could help combat ongoing price pressure.
  • Accelerate growth as a result of a broader suite of products, larger distribution network and enhanced market position.
  • Globalisation: clients are expressing a desire for global marketplaces and solutions from fewer partners.
  • Regulation/regulatory changes, including pending EU regulations that will promote competition in the areas of clearing, indexes, and data selling, in addition to challenging vertical silos by insisting that clearinghouses allow open access.

Given the headwinds facing the industry (low organic growth, intense competition and increasing regulatory burdens), M&A may be necessary to protect profit margins, serve client demands for global solutions and maximise collateral efficiency. I believe that the easy and obvious deals are done, and that horizontal integration is largely complete. I think vertical consolidation and diversification deals will now be prevalent, with the biggest challenges to M&A being regulatory reviews, home country bias and actually completing deals that are announced/contemplated.

Nonetheless, M&A will likely continue as issuers, investors, regulators and intermediaries become increasingly insistent that exchange operators provide open, efficient and competitive market places.