A Favorable Exchange

Turmoil is boosting trading revenue, but risks inflicting long-term damage
At Closing, June 18th
113.95 EUR

Volatility is a dirty word for most companies, especially when referring to the wild market swings seen over the past six months. For financial exchanges that profit from increased trading -- whether buying or selling -- it can be a blessing.

It just may not last.

As it posted a rise in fourth-quarter revenue on Thursday, Deutsche Boerse pointed to the helpful boost volatility gave its derivatives platform Eurex, which alone accounts for about 45 percent of group sales. Amsterdam-based Euronext said macro uncertainty had been a "significant driver" as it posted a gain in annual revenue earlier this week.

Favourable Exchange

Bourses have been outperforming financials

A look at the companies' share prices over the past year bears out the correlation with volatility: the euro zone volatility index, the VSTOXX, has risen some 30 percent and Euronext and Deutsche Boerse's stock has gained almost as much. Both have outperformed the broader Stoxx Europe 600 Financials index and have seen earnings-per-share estimates rise.

The problem for exchanges is that any short-term boost from volatility dissipates over time. In the long term, rocky market conditions can start cutting the number of IPOs and the revenue they make from listing fees. And if market turmoil forces central bankers to impose negative interest rates, that will hurt the profits exchanges make from the cash they enjoy when clearing and settling trades.

Added to that, regulators are threatening their own brand of volatility with the incoming Mifid rules. Regulated exchanges may benefit if more trading is squeezed out of dark pools -- on the other hand, the new rules also herald more competition in clearing and settlement as well as the overall threat of more regulatory costs.

In those circumstances, it may be better to be diversified. London Stock Exchange, which doesn't report results until next month, is the most advanced on that path. Over the last 10 years, it's made $6.2 billion of acquisitions. Its most recent, the $1.6 billion purchase of Russell's index business allowed LSE to tap the popularity of passive investing and exchange traded funds that track a multitude of industries.

Revenue Reliance

LSE derives a smaller proportion of revenue from trading and markets than its European peers

Source: Bloomberg data

Revenue from markets accounts for only 26 percent of the total at LSE, compared with about 51 percent at Deutsche Boerse and 60 percent at Euronext.

Valuations suggest investors are willing to pay for some predictability: LSE trades at 19.8 times estimated earnings for next year, compared with 16.4 for Deutsche Boerse and 14.1 for Euronext.

Premium Valuations

LSE trades at a higher multiple of estimated earnings than its peers

Source: Bloomberg data

But if volatility continues, Deutsche Boerse and Euronext's valuations may start to look more precarious than that of their British counterpart.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

    To contact the author of this story:
    Lionel Laurent in London at llaurent2@bloomberg.net

    To contact the editor responsible for this story:
    Edward Evans at eevans3@bloomberg.net

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