From the March 01, 2011 issue of Futures Magazine • Subscribe!

Traders without borders

imageThe trading world seems to be both expanding and contracting with the back-to-back announcements of two exchange group mergers. First is the London Stock Exchange (LSE) merging with the TMX Group, owner of the Toronto and Montreal exchanges. The combined market capitalization would be almost $7 billion. Next, the NYSE/Euronext and Deutsche Börse (DB), whose boards voted to merge on Feb. 15. That exchange could have a market capitalization of $24 billion. Derivative volume wise, it would mean about 5 billion contracts traded yearly, forming for the most part a single derivatives exchange in Europe. (See "Mega exchange on horizon?")

Two questions should be asked: 1) why are exchanges finding the need to merge? and 2) how will this affect exchange shareholders, brokers and, most importantly, traders?

It might seem curious that in the era of railing against the "too big to fail" scheme, exchanges would push for size. A cynic might say they learned "too big to fail" means the government would step in if problems occurred. More likely, with the explosion of other trading platforms, "dark pools" and electronic needs for speed and added geography, merging with the right partner can enhance an exchange’s ability to succeed in today’s jet propelled global trading world. The LSE/TMX merger is a good example of this; both are strong with mining, energy and metals company listings. In an age when commodities promise to increase in value, the new organization could attract more natural resource listings as well as keep those already on the exchange from going elsewhere.

The second question is more complex: How will this affect those in the business? Shareholders probably will do well in the end; when the NYSE/Euronext and DB merger talks were outed, share price for both exchanges jumped. For brokers, it might mean greater market access and potentially reduced fees because of cost efficiencies. Then again, it could mean a monopolistic clamp that charges brokers more because, hey, where are they going to go? And for traders whose clearing firms may have multiple memberships, this could reduce fees as a single clearing entity may mean greater ability to net margins across a wider area and benefit from a standardized exchange platform. Or it could mean the broker passes its higher fees onto the client.

Are these done deals? No, and a myriad of factors could hold them up. First: outside influences. Although LSE/TMX might be a close match, "national" pressure could foil it. And though the NYSE/DB boards approved the merger, external factors could cause havoc. Remember the Intercontinental Exchange bid for the Chicago Board of Trade (CBOT)? Major hurdles are the legal ramifications and regulatory approvals. The NYSE’s merger with Euronext already covers much of Europe, including exchanges in London, Paris, Brussels, Amsterdam and Lisbon, and the DB through Eurex owns the U.S.-based International Securities Exchange, so it won’t be a multi-country issue as much as it probably will be an anti-trust question on both continents. Having control of a good portion of interest rate derivatives in Europe could be seen as anti-competitive. And despite the Chicago Mercantile Exchange’s fight on the anti-trust question with the CBOT merger, you can bet the CME Group will (and already has) push that sticky wicket in Washington. No doubt the Nasdaq OMX will fight the merger as well.

The one thing that shouldn’t be used — and already has in some quarters — is the Dodd-Frank excuse. Specifically, that the new U.S. reforms will chase business overseas and a new mega exchange could promote that exit. Don’t hold your breath. European reform rules still are being written, and in this business, it’s best to know your risk before entering a trade.

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