Relations between London and Brussels have been better. As Brexit grabbed the headlines, another cross-channel development recently caught the attention of financial institutions. It concerns the proposed acquisition by the London Stock Exchange of 27 billion dollars (21 billion pounds sterling) of the American financial firm Refinitiv, on which the European Commission is conducting a thorough antitrust investigation.
With a decision expected in October, the commission will likely reject the deal in its current form. To get approval, LSE recently said it was selling either all of Borsa Italiana or its bond trading platform, MTS.
Why does the EU care about LSE’s acquisition of a US financial data company? And why would the LSE sell the Italian stock market to allay these concerns? The answer lies in the fact that the stock markets have fundamentally transformed over the past 25 years, as I demonstrated in a recent article. Much of this has gone unnoticed, and public perception clings to an outdated understanding of what trading is.
How the exchanges have changed
Stock exchanges are often still seen as quasi-public markets – icons embedded in nation-states and crucial to national economic development. But they have in fact become powerful global corporations that are actively shaping the development of financial markets around the world – with important implications for investors, businesses and governments.
As an article in The Banker said a few years ago: “Until the 1980s, exchanges would have been … recognizable by a trader who traded in the 14th century – at the time of their inception.”
Exchanges were once non-profit organizations, controlled by their members, with little agency. They typically monopolized commerce in their area and were physical places of commerce, such as the Chicago Mercantile Exchange, shown below.
It has changed in various ways. Financial liberalization reforms such as the European Directive on Investment Services (1993) created competition between stock exchanges. No longer monopolies but a market place for markets, they were forced to modernize and become more efficient and customer-oriented.
Most are demutualized and converted into listed companies. As one exchange official noted, they were now independent actors “fully responsible for their own destiny”. At the same time, they have also become for-profit businesses.
The shift to globalization has also resulted in increased cross-border financial integration. Along with increasing competitive pressures, there were opportunities to grow, acquire competitors, and venture into new markets. From Chicago to Singapore, futures exchanges started buying exchanges and vice versa, as well as trading platforms for bonds, carbon emissions, and commodities. Former NYSE CEO John Thain once observed that “every country has an army, a flag and an exchange,” but now the exchanges formed huge organizations across the world.
Finally, the stock exchanges have transformed from physical trading venues into financial technology companies. Face-to-face interaction on the floors has been gradually replaced by electronic markets. The director of an exchange said in an interview: “We are of course known as an American exchange, but this is only about 10% of our income.” Digitization had fundamentally changed this as market technology, data and indexes increasingly boosted stock market earnings.
The transformation of trade, 1980-2018
Exchanges are now actively creating, regulating and shaping markets around the world. They control the very infrastructure of global finance – data, indices, financial products, trading platforms and clearing, essentially deciding how markets work for businesses, investors and states.
Why LSE-Refinitiv is important
A hierarchy has also emerged, with LSE being one of the few global players that now dominate financial markets, along with CME, ICE, Cboe, Nasdaq and Deutsche Börse. These groups manage the most important, prestigious and profitable markets, and have the most important products, indices and technological know-how. Although there are more than 100 exchanges around the world, these six companies account for over 50% of industry profits and trades in stocks, futures, and options.
LSE is now a central hub of the global and, above all, European financial markets. It owns FTSE Russell, one of the leading index providers that guide investments by deciding which companies and countries are included in the indices followed by global investors – essentially acting as a guardian of global finance.
LSE owns LCH Clearnet, the world’s largest clearinghouse. Clearing houses act as intermediaries (or central counterparties) between buyers and sellers in transactions to transfer money and assets back and forth and act as guarantors for each transaction. They require investors to provide collateral, clearing houses basically decide what assets they deem secure enough to support financial transactions. During the eurozone crisis, for example, these operations had a significant impact on countries’ refinancing operations, as some government bonds were no longer considered safe.
LSE also owns several European trading platforms for stocks, bonds, derivatives and exchange-traded funds – including Borsa Italiana and with it the MTS platform. As Bloomberg recently noted, MTS is a vital part of the infrastructure of the European bond market with average daily trading volumes in excess of € 100 billion (£ 90 billion). It is a key place to negotiate the public debt of Italy and other European countries. Refinitiv (formerly the financial unit of Thomson Reuters) owns Tradeweb, an even larger bond trading platform.
With the MTS bond trading platform, FTSE Russell bond indices and LCH collateral rules, LSE’s acquisition of Refinitiv would have created a near monopoly in government bond trading infrastructure. European. With European sovereign debt already highly politicized in recent negotiations over the EU’s coronavirus recovery fund, an institution with the power to shape this market that will likely be outside the EU’s regulatory reach in December. is hardly acceptable to EU regulators. The EU has already blocked a planned merger between LSE and Deutsche Börse in 2017 for similar reasons.
With the threat of LSE market dominance removed, the EU could allow the LSE-Refinitiv deal to pass after all. But what this episode shows is that, as an essential component of global finance, trade has become important counterparts for states. What they own and the decisions they make have become matters of international political importance – and have added an extra layer of complexity for governments trying to set the rules for global finance.