A Swedish Surprise

OM's bid catches the attack on the London Stock Exchange off guard

With his neatly combed blond hair and youthful smile, 39-year-old Per E. Larsson does not look the part of the steely-eyed corporate raider. Yet the president and chief executive of Sweden's OM Group, a financial technology conglomerate that owns the Stockholm Stock Exchange, has just shown how wrong appearances can be. With OM's $1.19 billion hostile takeover bid for the London Stock Exchange, unveiled on Aug. 29, Larsson has managed to unnerve executives and institutional customers at nearly every one of Europe's 20 or so bourses.

OM's offer has disrupted the LSE's controversial plans for a merger of equals with Frankfurt-based Deutsche Borse, a move intended to create the long-awaited pan-European stock exchange. And it will almost certainly start a bidding war for the LSE, Europe's largest and most liquid securities exchange.

HIGH STAKES. Most important, Larsson's daring step could shatter the comfortable assumptions of most stock market strategists that the best way to set up a Europewide trading system is by merging national exchanges. "What's at stake is the shape of the coming pan-European market," says Brian Winterflood, chief executive of London-based Winterflood Securities Ltd. "OM's bid raises profound questions about that."

Larsson's company, which now accounts for just 5% of European equity trading, probably won't win control of the LSE. Indeed, LSE officials quickly rejected his initial bid. But Larsson's vision of how to create an efficient exchange could still triumph. Arguably, OM's most valuable asset is Jiway, an electronic-communication network, or ECN, of the kind that is seen as the real future of European cross-border trading.

Jiway, which opens for business in November, bills itself as the first completely integrated electronic exchange--offering trading, clearing, and settlement in more than 6,000 European and U.S. stocks. OM says trading on Jiway will cost just half of what it does on a typical European bourse.

ECNs have already snatched a quarter of Nasdaq's over-the-counter trading in the U.S., and there's no reason the same couldn't happen in Europe. After all, European Union law already allows stock exchanges to offer their services freely across national borders. So an ECN could easily handle trades for Siemens, Heineken, and BT British Telecommunications all in one system. "Given that," says the head of a Frankfurt-based mutual fund, "merging [old-fashioned] exchanges isn't necessarily the best way to attract liquidity."

LSE Chairman Don Cruickshank and Deutsche Borse Chief Executive Werner Seifert disagree. They say their merged exchange, iX, would satisfy institutional investors' desire for a broad trading platform and create the economies of scale needed for pan-European trading. Joining forces with DB "removes duplicate structures and market complexity," Cruickshank contends. "It will create a bigger, more liquid market, lead to lower dealing costs, and therefore be more attractive to investors and companies that want to list." OM's bid has "no merit," he adds, because it doesn't generate a "critical mass."

Larsson, backed by OM Chairman Olof Stenhammar, counters that merging two national exchanges doesn't necessarily boost efficiency. Investors will be better served, he maintains, if existing bourses have to win business by cutting costs and improving their trading systems. "Assisted by technology, exchanges need to go from being protected monopolies to service companies," he says. "Traditionalists claim that the biggest always wins. We believe in a more modern type of wisdom: The fastest wins."

Larsson argues that combining the LSE's liquid market and brand name with OM's state-of-the-art technology and commercial drive would create Europe's most nimble exchange by far. Brokers credit OM with developing one of the world's most transparent, efficient, and inexpensive trading systems. "This will give the LSE a competitive advantage to exploit global equity-market opportunities," Larsson says.

HEDGING BETS. Most big investors aren't taking sides in the battle between the traditional exchanges and ECNs. But they are eager--nay, impatient--for the fight to end and the long-promised pan-Europe market to arrive. Investment banks like Morgan Stanley Dean Witter and Merrill Lynch & Co. have hedged their bets by taking stakes in ECNs, the largest of which are Instinet (owned by Reuters Holdings PLC), Tradepoint Financial Networks, and Posit.

There's sure to be a day of reckoning. Equities trading in Europe has been expanding rapidly--by a remarkable 30% last year, according to Shroder Salomon Smith Barney. But there still isn't enough business to go round. Most analysts figure that only two or three bourses, or ECN markets, will survive.

That explains this year's wave of stock exchange mergers. In April, the Paris, Amsterdam, and Brussels exchanges announced they would join forces to form Euronext. A month later, the LSE and DB came up with their own merger scheme. The two exchanges together account for 46% of all equities trading in Europe. That's more than twice Euronext's market share. When Cruickshank and Seifert announced in July that Nasdaq might join their alliance, it seemed that the battle for Europe would soon be over.

But size, it turns out, isn't everything. After initially welcoming the idea of a merger, many British stockbrokers turned against it. They argued that dealing costs would still be too high and that many important regulatory issues hadn't been settled. They also feared that the plan to trade blue-chip stocks in London and growth stocks in Frankfurt would mean that the LSE, which currently boasts three times Frankfurt's trading volume, would lose business over time. By late August it looked as though the plan would be defeated when LSE shareholders gathered to vote on it on Sept. 14.

That crucial meeting has now been delayed. Most observers doubt it will ever take place. DB Chairman (and Deutsche Bank Chief Executive) Rolf E. Breuer says that Frankfurt may renegotiate the merger. Or, more probably, it will launch a friendly takeover bid for the LSE. But that's not likely to be well received in London. "The word `friendly' and the name `Seifert' do not go together," says the head of equities trading at a brokerage in London. He and others fear that Seifert, known for his abrasive style, would ride roughshod over the LSE. "A 50-50 merger was hard enough to stomach. But a takeover?"

A takeover by relatively tiny OM would not be any more palatable. Actually, a merger of any kind doesn't seem so crucial now. "OM has inspired us to ask whether we really need anyone," says London executive Winterflood. Either way, Per Larsson's audacious bid sends a signal that the game is far from over.