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Page last updated
February 15, 2003




Challenges and Opportunities for European Exchanges

There have been three major developments that characterise the changes in the European Exchange landscape over the past twenty years: the globalisation of financial markets, the revolutionary developments of technology, and European regulation. European Exchanges have reacted to the changes in their environment with, in several cases, drastic steps.

Currently, the Federation of European Securities Exchanges (FESE) counts 25 Full and 6 Associate Members, itself a testimony to Europe's variety and diversity on one hand and to the growing internationality of the business. After the political change in the early nineties, Exchanges were established in almost all emerging economies of Central and Eastern Europe. FESE's Membership extends today to all EU Member States, to Iceland, Norway, and Switzerland, as well as to six EU accession candidate countries: Cyprus, the Czech Republic, Hungary, Malta, Poland, and Slovenia. EU legislation has its influence today in all accession candidate countries; FESE keeps close bonds to the Exchanges in those countries and hopes to receive them as Members soon. Beyond this area, the Federation has regular contacts with many other Exchanges in Europe and invites them twice a year to join in the FESE European Exchanges Forum.

Recently, the Federation has opened its doors to the European Futures and Options Markets and their Clearing Houses; it has started to welcome derivatives markets and hopes to welcome clearing houses as Members later this year, thus becoming the voice of all regulated securities markets in Europe, especially towards the EU institutions, but also to FESCO (the Forum of European Securities Commissions), to the OECD, to non-European institutions, and to other sectors of the financial industry.

Globalisation of Markets
Supported by the developments in communication and information technology, financial markets have become truly global. Following the trend in the foreign exchange and international bonds sectors, the equities markets themselves have also moved from fairly national affairs to global cross-border operations. It is interesting to note in this context that the market mechanisms of those markets are now starting to follow in turn the equity markets, concentrating more than before on quality aspects such as centrality, transparency etc.

Trends on both sides of the market, supply and demand, have supported this move towards internationalisation. With the creation of larger and larger business units, many of them operating on a multinational scale, their demand for equity capital exceeded the amount of capital any closed economy would be able and willing to provide. More and more international corporations began to raise capital abroad and wanted, in parallel, to provide their investors with wider trading opportunities in their stocks.

This trend was accelerated in the nineties by the results of widespread privatisation programmes in practically every European country. These privatisations further increased the amount of investment required and added to the internationalisation of European equity markets. As an additional factor, tightening prudential regulation for banks in Europe reduced the attractiveness of corporate loan finance, notably in those countries where companies tended to rely heavily on debt rather than equity for the financing of their business.

On the demand side for good investments, the increase in volumes was to a large extent driven by the change in investment patterns of wide circles of the European population. Realising that state-operated pay-as-you-go pension schemes would run out of breath trying to cope with changing demographics, private provision started to take over. In addition, more and more European investors began finally to believe the truism that over a longer term, equity investments outperform investments in bonds. And thirdly, in several European countries, notably in those whose population had suffered most from the consequences of the (First and) Second World War, for the first time in a century a generation of heirs found themselves in a position to invest in securities more than their modest monthly income surplus.

After delivering valuable support in the areas of order routing, settlement and clearing, information distribution, and other auxiliary activities of securities trading, information technology started to offer solutions for the Exchanges' core activity, the matching of supply and demand including the finding of a "best" price for the trades. Electronic trading systems replaced the traditional trading activity on the floors of Exchanges where for centuries traders and brokers had struck their deals under the stringent requirement of physical presence. Communication technology made it possible to link traders in remote places to the trading mechanisms and to carry out (and settle and clear) large numbers of trades between participants that never saw each other.

Soon Exchanges, intermediaries, and regulators realised that any barriers for foreign investment firms to access to national Exchanges were neither timely nor wanted anymore nor could they be realistically upheld. And the single market for financial services had, moreover, become a prime target also for European politicians.

Following the opening of the single market for banks in the eighties, it was the EU's Investment Services Directive of 1993 that introduced the single passport principle, most notably for investment firms, but at the same time - and much less noticed - also for "regulated markets", i.e. the European Exchanges. From the very moment of the implementation of the ISD in their respective countries, European Exchanges have actively widened their Membership thus offering their issuers access to the international investment community.

European Exchanges Today
The European Exchanges of today rightly present themselves as modern, high-tech enterprises. They all operate fully electronic securities trading systems and have (with the exception of the German Exchanges) closed down their floors. They have invited foreign intermediaries to join the ranks of their clientele and many of them do a considerable share of their business with such remote Members.

The majority of European Exchanges is today demutualised. Following the trends illustrated above, namely computerisation and internationalisation, many Exchanges realised that their traditional mutual and non-profit structures (which had served them extremely well over many centuries and which had had their clear merits in earlier times) had become outdated and burdensome. Consequently, these Exchanges gave themselves a corporate outfit with modern and efficient decision structures and a clear profit orientation. Initially retaining part of the "Membership" concept through a limited circle of shareholders, some have advanced and offered their stock to other groups of their clients (investors and issuers), others again have gone public or intend to do so soon.

In several European countries, whole securities market services groups have grown around the "traditional" Exchanges, i. e. the cash markets. With very few exceptions, the national derivatives markets are generally found today under the same roof as the national cash markets. Some of these groups went further and integrated also their national clearing and/or settlement institutions, their IT provider, information distribution services and others.

Alliances and Mergers
But opening up to foreign (remote) Membership and internal restructuring were clearly not enough, particularly not in the eyes of those global intermediaries that - as a consequence, among others, of demutualisation; were clients and became shareholders of many of the leading European markets at the same time. The benefits of being technically able and legally permitted to link up to any Exchange within the EU were clearly hampered by practical obstacles. Almost every Exchange operated its own distinct trading system and every Exchange had its own in-house and national regulatory requirements. Through their new, corporate channels of influence, these global financial players eventually started to strongly suggest to their Exchanges to develop solutions for a further reduction of costs for those intermediaries operating on more than one market. In addition, and driven by their new for-profit business concepts, Exchanges themselves sought methods to curb their expenses. And they arrived at solutions that have indeed been very common in other sectors of the economy for many decades: co-operation, alliances, mergers.

Following the internal concentration process in almost all European countries (today, only in Germany and Spain still exist regional Exchanges), the European Exchanges started different forms of international co-operation. Some like ParisBourse started early selling their trading system to other Exchanges, thus reducing development costs there and at the same time providing foreign Members with a trading environment already familiar to them.

"Practical" alliances followed, providing cross-membership and cross-access facilities (e.g. in the Benelux countries), harmonised listing requirements (e.g. for the markets participating in Euro.NM) and cross-listings of products, most notably on derivatives markets. The "European Alliance" of eight Exchanges, although eventually perhaps going less far than expected, provided valuable input towards the harmonisation of the European Exchange landscape, for example by defining a joint market model and an effort to harmonise operating hours.

The first cross-border merger of Exchanges in Europe happened even across the borders of the EU when the national derivatives markets of Germany and Switzerland created Eurex. Last year, another big merger project has become reality: Euronext, the merger of the Exchanges of Amsterdam, Paris, and Brussels. A new, joint corporate structure has been established by its three participants; the "amalgamation" of trading, clearing, and settlement systems is proceeding according to plan. Euronext is open for other European Exchanges to join; discussions on this issue have begun, for example, with Lisbon and Luxembourg.

Norex and Virt-X, the two other current major alliance projects in Europe rely on the use of one trading system and a common regulatory framework by several Exchanges that remain separate legal entities. A similar approach has, by the way, also been chosen by two smaller European Exchanges (Vienna and Dublin) who operate their equities markets on the German XETRA system. The XETRA system is also being used by Newex, a niche market established by Deutsche Börse and the Vienna Stock Exchange with a focus on stocks from Central and Eastern European countries. Newex in turn intends to set up co-operations with local Exchanges in those countries. The acquisition of a majority stake in the shares of the Tallinn Stock Exchange by the Finnish HEX Group was the first example for a friendly take-over in the sector.

The Challenges from Alternative Types of Exchanges
During much of the year 2000, the future of electronic Exchanges and the establishment of the first European ATSs was a hot topic among conference organisers all over Europe. Until today, however, ATSs and ECNs have failed to duplicate to any relevant extent the great success they seem to have had in the US; at least during boom times. True, in creating and/or exploiting market niches, alternative market operators have found their business opportunities: EuroMTS is a successful wholesale trading system for European government bonds; in a sector where European Stock Exchanges had lost much of their business already long time ago. (I have mentioned above that market participants now seem to love the idea of the government bond market returning into the "safe harbour" of a regulated market after thriving for many years in an OTC environment.) Coredeal, also a regulated market, successfully entered the wholesale market niche for corporate bonds. And Jiway offers to its customers access to a series of major European and North American markets while having the status of an EU regulated market itself.

Several reasons have been identified why the market entry for ECNs is certainly much more difficult (if not impossible) in Europe than on the other side of the Atlantic. The two most striking ones are:

n European Exchanges are; technically speaking - ECNs today. All core definition elements usually found in descriptions of ECNs (except the legal one that ECNs are by definition non-Exchanges) can also be found at Europe's fully computerised market places. What a difference to the situation in the US! The New York Stock Exchange and NASDAQ operate in the largest single market of the world; but today are themselves neither electronic nor demutualised.

n European Exchanges operate on the basis of the most advanced market models or have committed themselves to do so in the very near future. They have understood that a central counterparty system with netting facilities across markets, both on the cash and on the derivatives side, is what their Members and shareholders want and need. Trade anonymity, of course paired with an efficient regulatory reporting system, is the standard of modern securities trading.

It is with natural interest that the Federation and its Members watch the development in the regulatory discussions about ATSs in Europe. Similar to the approach by the US SEC (where ECNs need not necessarily register as an Exchange but can be permitted to offer their market services as broker-dealers) some propose to submit ATSs to a lesser degree of regulation and supervision than "traditional" Exchanges. The Federation is not convinced that this approach is justified and that the risks evolving from ATSs' operations as market services providers are by nature less than those from "traditional" Exchanges' operations. Far from suggesting a protective environment for FESE's Members, we believe that a level playing field for all providers of essentially the same services is more than fair a demand. The recent proposals put forward by the European Commission for consultation on the review of the ISD and by FESCO provide only some clarity to this issue but delivered a good basis for further discussion

The Challenge in the Back Office
In economic terms, European equities markets are not (yet) fragmented. This is to say that basically for every European financial product there is one key market where 80 or 90 or, in many cases even 100 per cent of liquidity are concentrated. They are, however, very fragmented in regulatory terms and in technology.

As mentioned, co-operations, alliances and mergers between some European Exchanges already address this problem. The real issue and the hot topic of this year is the fragmentation of the cross-border clearing and settlement landscape.

Statistics are well known that the "cost of trading" on European Exchanges is "ten times higher than in the US". This "truth" stands in striking contrast to the recurrent findings of researchers who actually compare the costs of trading on various Exchanges all over the world. Leading European Exchanges regularly finish among the top five (i.e. among the cheapest) of all securities markets if the mere costs of the Exchange transaction are counted. What "kills" them is the cost of settling and clearing these transactions through a maze of national and international CSDs and clearing houses; including of course the high fees investment banks often charge their clients to find their way through this maze.

The current consolidation process among European Exchanges and the formation of a handful of pan-European alliances and/or mergers addresses this problem, maybe to a varying degree in the different projects under way. The ultimate goal of creating cheap and efficient back-office solutions is in any case in the focus of the Federation's Members. They know that time is running against them and that successful mastering of this challenge is crucial for the continuing support from their Members /shareholders.

One market-driven proposal to install one central, non-competitive, non-profit central counterparty clearer in Europe has for the time being put on hold, but others have been heard loudly to demand that such a structure be installed from above, by regulators or by the European Commission. The Federation is evaluating the proposals ands is taking an active part in the related discussion. While such an idea may seem attractive at first sight, concerns about the disadvantage of any monopolistic structure must not be disregarded. We feel that in any case the formation of a European clearing structure should; as for markets themselves; be left to the private sector.

The Challenge in Regulation
Regulatory fragmentation in Europe is a fact given the constitutional structure of the European Union and its Member States. The single financial market policy by the European Commission tries to reduce the effects of this fragmentation by working towards a removal of barriers between jurisdictions.

The EU Commission's Financial Services Action Plan of 1999 sets out to make decisive steps towards a further improvement of the single market in no less than 43 different areas. The Federation fully supports the thrust of the Action Plan while of course not in every detail subscribing to every proposal put forward by the Commission. We have found, though, that to a much greater degree than in earlier times, the Commission has an open ear to the financial services industry and is indeed actively trying to receive and to process input from market participants, including Exchanges. The Federation has received and noted with interest the recent proposals by the Commission on the review of the ISD, on market abuse, on prospectuses, and on transparency requirements for listed companies. These documents provide ample opportunity for discussion by the industry, by and with governments and regulators, and with the Commission and the European Parliament.

This European Parliament has become a true co-legislator of the European Union through the last revision of the Treaty. European Parliamentarians have therefore become much more interested in; and much more important as targets of; information on developments in the financial sector in Europe. The Federation has therefore co-founded a group of leading European financial service providers and institutions with the aim to provide MEPs with information on trends and issues.

The earlier observation that European regulatory fragmentation is a fact and will remain a given for quite some time to come also provides the answer to the question whether a joint European Securities Regulator and Supervisor (something like a European SEC) should be established. For the time being and indeed for any foreseeable future, such a European SEC would basically have to operate many separate departments dealing with the regulatory environment (and in particular with enforcement issues) in each EU Member State; not a promising outlook.

FESE strongly believes in regulatory harmonisation but sees much greater potential for success in a strengthened co-operation of the existing national regulators. The Group of Wise Men installed by the ECOFIN Council in July 2000 and chaired by Alexandre Lamfalussy has in its report also strongly recommended such an approach. FESCO has since its inception provided valuable work in this field and is now being transformed into CESR (the Committee of European Securities Regulators) under the Lamfalussy proposals. FESE encourages CESR to continue with their efforts and strongly suggests to extend the scope of consultation with market participants with the aim of arriving at fair, dynamic and, practicable regulatory solutions.

Proximity to the markets to be regulated has always been the success story of good regulators; the Members of FESCO/CESR are those who are and have always been close to their respective home markets. In a European institutional framework, the two new Lamfalussy Committees with their role in fine-tuning legislation can help make European legislation faster and more flexible.

Trans-Atlantic connections
One additional, non-European regulatory challenge has also to be mentioned here: While US American market services providers can already today find relatively easy access to clients in some European countries (and, consequently, through single passport arrangements in all of the EU), European Stock Exchanges remain barred from directly gaining US intermediaries and investors as their clients. We believe that European Exchanges today are competitive and ready to compete with their peers in other time zones. Restrictive practices as employed by the US SEC have no place and no justification in today's world of basically free trade. FESE and its Members continue their lobbying efforts in the US and have secured themselves the support of the European Union and of other international institutions.

It is encouraging to note, on the other hand, that the CFTC; the US regulator for derivatives markets; has taken a more open attitude allowing several futures markets the opportunity to offer access to US clients. The imminent change at the top of the SEC may provide a new angle to this problem.

An Outlook
What will the European Exchange landscape and, more general, the structure of financial markets in Europe look like in several years' time? Not easy to predict since not all key influences are predictable. Nevertheless, the Federation of European Securities Exchanges has drawn up a scenario; composed from the interpretation and extrapolation of current trends and from a few desiderata:

n The number of Exchanges (securities market operators) in Europe will not decrease, rather grow through the advent and foundation of new operators. Mergers of Exchanges may occur in a few instances, but corporate amalgamation of Exchange operators is not really the key issue.

n Local Exchanges will be integrated into wider co-operations with joint "production facilities", i.e. trading systems. These Exchanges will, however, remain the key business partners for their regional clients (issuers, intermediaries, and investors). Some will be able to exploit regional and/or topical market niches for a limited time.

n The number of trading systems used by European market places will shrink drastically; this is one of the areas where economies can be achieved by market operators as well as by their clients, i.e. the intermediaries.

n New types of market operators (ATSs in the widest sense) will thrive in certain niches of the market (wholesale markets, bond markets, and others). Their "products" will have life cycles of varying lengths. "Regulated Market" will become even more of a quality label for high-standard markets; its use will have to be monitored and regulated in an efficient and responsible manner.

n It may happen that markets for individual stocks will become fragmented - also for a limited time. Liquidity considerations together with transparency requirements and Conduct of Business Rules for best execution will result in later re-consolidation of market activity.

n The settlement process in Europe will be streamlined and concentrated in the hands of few services providers (or groups of providers), operating on a pan-European scale. The "monopolies per market" (i.e. the fixed links between national markets and their national settlement institutions) may be broken up in many places.

n Clearing will likewise be concentrated, although possibly not in one, European central Clearing House; concerns over the disadvantages of a monopolistic solution and over risk-concentration may outweigh possible advantages. The key to success, however, lies in cross-netting facilities between Clearing Houses, across borders and between cash and derivatives markets.

n Despite all further harmonisation of laws and regulations, legal fragmentation will continue to prevail, given the constitutional structure of the European Union. Therefore, the idea of a joint European supervisor/regulator seems premature. The co-operation between national supervisors/regulators must and will be extended, FESCO will be put on a stronger institutional basis and its activities will be intensified. The implementation of the Lamfalussy proposals will hopefully create the opportunity to accelerate the legislative process in the Union and to make this process more flexible through the inclusion of regulators and national experts.

Dr. Gregor Pozniak
Deputy Secretary General
Federation of European Securities Exchanges, Brussels



Dr. Gregor Pozniak is the Deputy Secretary General of the Federation of European Securities Exchanges (FESE). Within the Secretariat of FESE, Gregor focuses on European regulatory and legislative issues, and on the contacts of the Federation with Exchanges and organisations outside the EU/EFTA zone.

He joined the FESE Secretariat in 1998 after three years as Head of Listings and Membership at Vienna Stock Exchange where he contributed to develop the new face of the Exchange towards its major clients - members and issuers. Before joining the Exchange he was Head of Fixed Income Research at Creditanstalt Vienna where he had worked for eight years.

Gregor is a regular speaker on European Stock Exchange issues and on EU developments in financial markets regulation.

He holds Master's and Doctoral Degrees from Vienna University of Economic Sciences and has studied at London Business School and Georgetown University, Washington D.C.

The Federation of European Securities Exchanges (FESE) is the association of regulated securities markets in Europe. Established in 1974 as a small forum of Stock Exchanges in Europe, FESE today counts 25 Full Members from the countries of the EU and the EFTA, as well as six Associate Members and several Corresponding Exchanges from EU accession candidate countries. The Federation has recently opened membership to European derivatives markets and clearing houses. Under its new name "Federation of European Securities Exchanges", it will form a true association of European quality securities markets. The co-operation with European clearing and settlement organisations will be intensified.

Its objective, broadly stated, is to contribute in the fields of securities markets to the attainment of the aims of the Treaties of the European Union. It seeks to promote the development of securities markets in Europe and represents its Members to the European institutions. It serves as a forum in which Exchanges, clearers and other service providers discuss the needs of market users and look for agreement as to how those needs can be met. Through joint action the Federation's Members endeavour to create the infrastructure needed for efficient markets in Europe.


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