Faster, Cheaper, Bigger: Revolution In The Bourses

European exchanges gird for a titanic struggle, propelled by technological change

A storm is sweeping across Europe's financial exchanges. The London Stock Exchange has been crowing about switching to a fully automated trading system by Oct. 20. But on Sept. 17, the Frankfurt, Paris, and Zurich exchanges stole some of the LSE's thunder by announcing a broad linkup in derivatives trading. What's more, the three bourses plan to merge all their markets, including stock, fixed income, and derivatives trading and clearing, by 2001.

Europe's bourses will never be the same. The battle of the exchanges is forcing them to consolidate and pushing brokers to cut commissions, which have long been higher than those in the U.S. As European investors pour more money into equities, they will find bourses with more transparent pricing and greater liquidity than ever before. And with more capital flowing in, companies will find it easier and cheaper to raise money, too.

With the expected advent of the single European currency in 1999, Europe's markets ultimately may coalesce into just three or four electronically linked financial zones. One such zone might encompass Germany, France, Switzerland, and the Benelux countries. London could be another, and the Scandinavian countries might hold out for a third. Indeed, the Stockholm and Copenhagen exchanges already have announced their intention to merge. "Little exchanges no longer make sense, technologically or economically," says Werner G. Seifert, CEO of Deutsche Borse Group, the company that operates Germany's markets.

THE INTERNET THREAT. Exchange officials also worry that technology may make bourses obsolete. They realize that if they don't keep modernizing, cutting costs, and providing the services their customers want, they could find themselves eclipsed by the explosion of the Internet and other new electronic systems. "The concern of all the European exchanges is surviving against" newer systems, says Martin Wheatley, head of development at the LSE. "With the advance of technology, exchanges with physical walls are under some threat."

Already, a startup called Tradepoint Investment Exchange is nipping at the LSE's heels. A licensed stock exchange based in London, it is completely electronic and allows its participants, who include nearly all the top banks plus big-time fund managers, to trade with each other online, bypassing intermediaries. Traders at the big banks also are steering some of their business to Tradepoint--in part because they like having an alternative to the LSE. Last summer, three of London's four interdealer brokers--who arrange trades among market makers--chipped in some $4 million to keep Tradepoint afloat. With their business threatened by high LSE fees, they are now considering shifting their deals, which amount to roughly 15% of the LSE's volume, to Tradepoint's system. The LSE recently slashed its fees by 60% to undercut Tradepoint. "We didn't want to put in the money, but it is looking like a good investment," says an executive at one of the interdealer brokers.

Spending big on technology also seems to be paying off for Frankfurt's fully electronic DTB futures exchange in its battle with the long-dominant London International Financial Futures Exchange (LIFFE). In August, DTB shocked the LIFFE by capturing 43% of the market for trading in German government bond futures. LIFFE is still leaps ahead in the options market, because traders prefer the faster execution of LIFFE's trading pits. But the major test will come when trading begins in contracts denominated in the new euro. DTB officials think their electronic trading system, which will be in place for the launch of the euro, will give it the advantage.

Not too long ago, it appeared that London might wipe out its European competitors. Even now, its domestic market capitalization of $1.7 billion is more than double that of Frankfurt, Europe's No.2 bourse. London got a big headstart from its 1986 "Big Bang," in which it abolished minimum commissions, eliminated the trading floor, and permitted foreign companies to own member firms. But the LSE continued to be dominated by a club of market-makers in stocks, while rival exchanges in Frankfurt, Paris, Milan, and Stockholm invested heavily in technology.

Although tiny compared with the LSE, Stockholm is now seen as Europe's most progressive stock exchange. Its automated system enabled it to slash its trading fees by two-thirds and boost its transaction volume twenty-fold. It went from a member-controlled organization to a private company in 1993, and has extended trading hours to attract international investors. Those investors now account for more than a third of Stockholm's trading--helping its market cap triple in the last four years.

London is feeling pressure to catch up. Indeed, the European challenge is one of the reasons that London traders are forgoing their precious fly-fishing and golfing and trooping into their offices for weekend "dress rehearsals" on the LSE's new system.

PUSH-BUTTON TRADES. London has eliminated its expensive trading floor. But its old-fashioned quote system, where bid and offer prices are posted electronically but actual trades are made through a group of market makers, annoys some customers. First, it tends to produce wider spreads between bid and asked prices--about 0.6% on the average trade, compared with 0.1% to 0.2% on some of the Continental bourses. More important, because market makers can wait up to five days to notify the market of large block trades, it can be hard to determine what the real price is. "You often ask yourself what the heck is going on here," says one major fund manager.

The LSE thinks its new system will cure many of these ills. Limited initially to the biggest 100 stocks, the system will offer an electronic "order book" that will more efficiently match buyers and sellers. Member firms will be able to execute orders at a given price by pushing a button. Actual prices, rather than bids and offers, will be posted in the order book, making trading fairer.

Some members grouse about the cost of revamping their trading platforms in preparation for the new system. But the LSE, which is investing $130 million itself, thinks doing so will pay off. In the first year alone, the LSE, based on other exchanges' experiences, expects to double the number of trades. The LSE also believes that an automated system will bolster fast-growing derivatives-related and program trading, activities in which London lags the Continent.

But that may not be enough in a financial world in which the pace of change is accelerating. Even cautious Frankfurt is cutting its fees to match London's. An upgraded electronic system, to be introduced in November, eventually may force the closure of Germany's eight stock-trading floors--the last of their kind in Europe. In a few years, there may be only "one big European market," says Steven Kendall, director of European equities trading at NatWest Securities. Across Europe, the winds of change are only just beginning to howl.

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