To Merge, Or Not To Merge?

Anybody with eyes caught the Tokyo Stock Exchange (TSE) and Osaka Securities Exchange (OSX) announcement yesterday that the former's tender for its rival had been successful. Moving on, TSE president and CEO Atsushi Saito outlined plans to become a regional powerhouse in securities, with the merged businesses tentatively named the Japan Exchange Group.

The deal, worth around $1.7 billion, has already been granted regulatory approval in the country, something that seems relatively foreign to say given the attempted mergers and acquisitions over the past few years. Everyone knows about the failed plans for a superhouse between NYSE Euronext and Deutsche Börse, of course, which was blocked by the European Commission on anti-trust grounds. Likewise, the London Stock Exchange's failed bid for the Toronto exchange made headlines, as did the Singapore Exchange's aborted tie-up as well.

Head wind
But, the climate seems to be changing, somewhat. Maple's bid for TMX in Canada has completed, with a possible view to US exchange Direct Edge afterwards. Singapore has been talking about extending its operations with other bourses, although has categorically ruled out any kind of merger for now.

As exchanges adapt to the changes in regulation sweeping the world, and diversify their businesses through dark offerings, added-value services and clearing, technology is leading the charge, still. They still have a reputation for being first-in-class when it comes to the tech power they can provide, even if there are grumbles about them essentially becoming vendors. Millennium IT, like Richard Branson, for instance, is super-fast. Even in the public perception they're seen as having primacy - ask the average punter on the street who they think the most advanced institutions in finance are, and they're unlikely to say Cloak-and-Dagger Capital Markets with a one-page website. They'll probably say a stock exchange (and, until recently perhaps, banks).

Bumpy Roads
It's not been a smooth path for exchanges of late, though. From the Facebook initial public offering (IPO) that seems to have been botched spectacularly by Nasdaq, much to UBS and Citigroup's chagrin, through to the volatility in Peet stock on Wednesday, these firms still seem to be ironing out the kinks in a market that has become increasingly irregular, particularly with the advent of algorithmic and high-frequency trading (HFT).

It's unlikely that regulators will allow the creation of enormous entities without guarantees of performance and uptime, not to mention the stability of systems and the mitigation of inherent risk a collapse engenders.

Some of it's not their fault, of course. Nobody could predict that Knight Capital would implode so quickly due to what's being described as a legacy hangover, or that it would have to be rescued by an industry consortium of rival market-makers, leading to saccharine articles in Forbes about character and strength on Wall Street. However, the frequency of tech issues, and the consistent indications of HFT imbalance, are pushing towards increased oversight.

"First the Facebook debacle, then Knight Capital and now Peet's Coffee and Tea," says Rik Turner, senior analyst at Ovum. "The world of automated trading, to which the high-frequency variant has added piquancy, is back in the spotlight this week as yet another technical error causes short-term distortions in a market already fretting about on going global economic woes generally and Eurozone sovereign debt in particular.

"This latest glitch can only increase the volume of calls to ban, or at least seriously restrict, the activities of the HFT community, though it is Ovum's contention that, rather than imposing constraints on HFT, the regulators would do better to encourage the adoption of faster and better monitoring technology at the trading venues," he continues.

Indeed, some exchanges are practicing self-regulation to an extent, with various messaging efficiency programs. I covered it in-depth earlier this summer, but there aren't broad indications that it's been an enormous success as such. Direct Edge abandoned its own messaging program, which sought to charge a premium for flooding the market with quotes that don't result in trades. Nasdaq, which famously launched its own at the same time, confirmed to me yesterday that theirs is still in operation.

Future Proofing
If exchanges want to pursue increased conglomeration, then there are still a few details to be ironed out. Single-stock crashes seem to be happening with increased frequency of late, and there's still no politically palatable solution to overseeing HFT, even if the Securities and Exchange Commission (SEC) has decided to step into the modern age and, you know, actually oversee the market.

TSE-OSX, therefore, is a bit of a blip at the moment. It's unlikely that regulators will allow the creation of enormous entities without guarantees of performance and uptime, not to mention the stability of systems and the mitigation of inherent risk a collapse engenders. Anti-trust concerns, it would appear, are the polite way of saying ‘Not until you get your house in order, lads.'

If you'd like to talk exchange mergers, flash crashes, HFT or why crouch-touch-pause-engage is now crouch-touch-set (I still don't understand that), feel free to call on +44207 316 9811 or send an e-mail to james.rundle@incisivemedia.com.