Frankfurt's Power Play

Can the German bourse make itself dominant in Europe?

The battle to become top gun among Europe's stock exchanges has begun. On Dec. 6, Deutsche Borse chief executive Werner G. Seifert fired the opening shot by announcing he will take the Frankfurt exchange public, seek foreign investment banks as shareholders, and quickly push into online trading. His moves sound the death knell for the European Exchange Alliance of eight national stock exchanges, which has been trying for a year to agree on a common trading system for Europe's most liquid big company stocks. Seifert promises to rebaptize DB as the Euroboard, but that isn't fooling anyone. "We're going to see a fight for supremacy between DB and its rivals," says the head of equity trading at a large U.S. bank in London.

It won't be pretty. Europe's stock markets are expanding at a rapid annual lick of 30%, but there simply isn't enough business to go around. Last year, shares worth $10 trillion were traded in all of Europe, vs. $12.6 trillion in the U.S. More than a dozen national stock exchanges, from London to Milan, will try desperately to protect their turf. They will have to compete with Nasdaq, which plans to set up a European trading operation by the end of next year, as well as new electronic communications networks, such as Tradepoint Financial Networks, Instinet, and Posit. Already such hi-tech systems, which make dealers obsolete by matching equity sellers with buyers directly, have snatched a quarter of Nasdaq's over-the-counter trading in the U.S.

Institutional investors, the huge pension, mutual fund, and insurance groups, will decide the outcome. They want a liquid, transparent central market where they can deal in Europe's top 400 companies quickly and cheaply. "Just one or two exchanges will dominate the market in the long run," says Alan Line, head of trading at Foreign & Colonial Eurotrust PLC, a London investment trust group.

Will the Deutsche Borse be a survivor? It certainly has some advantages. Although this year it has slipped from second to third place--behind London and Paris--in total market capitalization, it is more than a basic stock exchange. The Eurex cash and derivatives exchange is an integral part of the bourse. Frankfurt has an efficient settlement system, another plus-point with investment pros. It has also developed the successful Neuer Markt, an exchange set up in March, 1997 for high-growth stocks, which has just listed its 200th company. If DB can now provide cost-effective trading in European blue chips, it could soon pull ahead of its slower rivals.

That's a big if, though. Initial indications are that the investment banks Seifert hopes will buy up to one third of DB's shares--mainly the big Wall Street, French, and Swiss houses--aren't all that interested. An official at one says that the $500 million price tag for the stake is too expensive. The banks already bought into London's Tradepoint for a fraction of that amount and gained an entree into a Europewide system that launches in mid-2000. Indeed, Tradepoint could prove Seifert's most formidable rival.

Seifert could increase his odds of coming out on top by merging with a competitor such as the London Stock Exchange or the Paris Bourse. "I don't think a pan-European exchange could exist with just Frankfurt as the anchor," says a German institutional investor. Many bankers and analysts favor a Frankfurt-London or Frankfurt-Paris combination. Such lineups might outdo rivals. First, of course, London would have to adopt the euro as its currency. Then the exchanges would have to learn to cooperate.

ABRASIVE STYLE. Their recent history isn't encouraging. Consider the ill-fated attempt to set up the alliance of European exchanges in the first place. The national stock exchanges, led by London and Frankfurt, realized that if they didn't come together to provide a common system for institutional investors, someone else, such as Tradepoint, would. Or that the institutions would set up a such a system themselves, as some are now doing. This summer, for example, nearly two dozen fund managers led by Merrill Lynch's Mercury Asset Management unit and Barclays Global Investors, agreed to launch E-Crossnet to trade European stocks between themselves.

The exchanges' attempt to work together foundered because they couldn't agree whose technology to use. Predictably, Seifert championed the Frankfurt Xetra system, while London defended its SETS technology. The situation was aggravated by Seifert's abrasive negotiating style. The European alliance finally agreed on a plan in September to harmonize its members' trading systems and rulebooks by November, 2000. But investment bankers quickly dismissed the plan as inadequate. Now it's moot.

While discussions between Frankfurt and London dragged on, Reuters Group PLC's ECN subsidiary Instinet formed a consortium of leading investment banks--including Morgan Stanley Dean Witter, J. P. Morgan, and Warburg Dillon Read--to inject $22.4 million into Tradepoint. The Reuters unit will set up the Frankfurt European trading system by mid-2000. In November, Deutsche Bank joined by buying a 9.7% stake. Michael Phillipp, the bank's head of global equities, says Deutsche wants "to play a key role in shaping the future landscape of European and global securities trading." Deutsche's decision came after Chief Executive Rolf-Ernst Breuer had said publicly that "the patience of the large investment banks [with the EEA] is at an end."

HIGH AND DRY. Deutsche's decision to back Tradepoint was a body blow to DB's aspirations and apparently rattled Seifert. Breuer is the market's chairman, and Deutsche Bank is a large shareholder. In any case, Seifert was losing patience with the wrangles that bedevilled the alliance, and he was annoyed that the other members rejected Xetra. Nasdaq's Nov. 8 announcement was the last straw. All of a sudden, it looked as though Frankfurt could be left high and dry.

To succeed, Seifert will have to transform his market into Europe's first continent-spanning stock market quickly. An agreed merger with another major market--and instant harmony over complex technology issues--are certainly the minimum conditions for staying in the race. The weight of all the failed earlier attempts could prove an insurmountable handicap.