Global barriers are falling as stock markets urge to merge

Adding to the frenzy of late is fear – the fear of being left behind, and losing out to rivals who move more quickly to link up across national borders and snatch the lead in catering to the international investor. Moreover, if the national exchanges don’t take the initiative, they could be bypassed by new electronic trading systems, such as the so-called ECNs and others, with often-superior technology.

It’s hard to say for sure who will be the winner — or winners. Because the New York Stock Exchange and the Nasdaq Stock Market in the US are the world’s two biggest markets, measured in market value, and the US is the world’s biggest economy, both almost certainly could be major players. But they risk seeing their leadership erode.

Michael Clark, head of stock trading at Credit Suisse Group’s Credit Suisse First Boston in New York and a fan of globalization, says US exchanges have been too slow to automate and to streamline their ownership structures. If that slowness continues, he says, they could lose business to nimbler overseas players, particularly in Europe, whose exchanges have moved more quickly to embrace new technology.

"I think the NYSE and Nasdaq together define a US marketplace that is really a global franchise. It would disturb me to watch that erode," says Clark.

Hence the recent flurry of activity. Several smaller exchanges in Europe have come together. Markets in Paris, Amsterdam and Brussels are forming Euronext, while a group of Scandinavian markets have agreed to form Norex. Those deals prompted the London Stock Exchange and Frankfurt’s Deutsche Bourse, which had long been talking about a merger, to get their act together and announce plans to merge into a new market called iX.

Nasdaq, meanwhile, has been the quicker of the two US exchanges. It has joint ventures and alliances in Japan, Hong Kong, Australia, Canada and a joint venture focusing on growth stocks with the proposed London-Frankfurt exchange in Europe. Later this year, Nasdaq officials plan to talk to exchanges in Latin America and the Middle East.

The New York Stock Exchange, for its part, is discussing alliances with markets in Canada, Latin America and Europe, it was disclosed last week. The Big Board also is talking to the Tokyo Stock Exchange about creating common listing standards, and it wouldn’t be far-fetched to see those two marketplaces come together more directly, just as the baseball industries of the US and Japan have drawn closer, spurring visions of a true World Series merger someday.

On one level, all the consolidation makes perfect sense. The current regime of locally based stock markets loks fragmented and archaic given that exchanges often function as mere utilities that match orders, especially for big, easily traded issues like Microsoft Corp that interest investors in many countries.

True, most people agree there still needs to be a central place for buyers and sellers of stock to come together. But in the Information Age, who says` that central place has to be in any one town or country? Investors aren’t limiting themselves by geography when selecting which stocks to buy. If they don’t see any difference between shares in companies based in Houston vs. Hong Kong, why should the exchanges?

"The rationale for national stock exchanges is completely gone," says Michael JP Marks, a Briton who is a member of the executive management committee of Merrill Lynch & Co. and a director of the London Stock Exchange. Big investors don’t think country-by-country any more, he says; rather, they compare companies in the same industry scattered all over the world. Such investors want simpler and cheaper ways to trade globally.

Others aren’t willing to go quite that far but agree that national lines will blur.

In the future, "I believe that at any point in time there will be one dominant [trading] pool per instrument that might not be on national lines," says Doug Atkin, president and chief executive of Instinet, a Reuters PLC unit that is one of the largest of the ECN trading systems and also a brokerage firm. Atkin figures there will be several of these trading pools, though fewer than there are now.

But despite big predictions and the flurry of deal-signings by the exchanges, not much has actually happened yet and lots of questions remain.

The announced merger between the London and Frankfurt stock exchanges faces plenty of hurdles at home, and its joint venture with Nasdaq is limited to "high growth" stocks (likely to be a lot of young tech stocks) rather than existing European blue chips. An eventual merger with Nasdaq is just a distant vision.

If the global exchanges don’t move quickly, the upstart, specialized trading systems will be happy to take their market share. In the US, ECNs, still largely tied to Nasdaq for their livelihood, are looking for ways to become more autonomous and grab an even bigger piece of trading volume than they already have. Some have even filed to become exchanges themselves. But some market watchers think the greater threat to established exchanges is their peers, particularly those who make smart deals with each other.

Regulation is also an issue. There’s the question of how long a global evolution will take given steep differences in how stock trading is policed among countries. These gaps could hinder some stocks from trading freely in the US, home of the world’s largest pool of money, and elsewhere.

A foreign company’s shares can’t trade in the US unless they are registered with the Securities and Exchange Commission and the company meets US accounting standards. A US investor can still buy the foreign shares through a broker, but often the trade must ultimately be processed by a foreign broker in the home country. Formal linkages are complicated by the different rules and trading systems of the various markets.

"Accounting is probably the toughest nut to crack because it goes to national company law, and national company law is about as intimate and personal a national characteristic as you can get," says Fields Wicker-Miurin, who focuses on financial markets issues for Vesta Capital, a London venture-capital and incubator firm.

In Europe, meanwhile, trading-matching systems are coming together faster than the key "back office" functions that process the trades afterward. Meantime, cross-border trading, even within the euro currency zone, remains considerably costlier than home-market trades.

It’s also uncertain how much all these changes will really benefit small investors in the US and elsewhere. Investors effectively can already trade any stock they want, US or foreign, and will probably always need to deal through brokerage firms anyway (whether traditional or online).

Do investors really want to trade a stock while the company’s home market — and biggest pool of trading liquidity — is asleep? Yes, say some market watchers. It already happens with stocks, like BP Amoco PLC, that are traded heavily both in London and New York.

But others say companies like BP Amoco are the exception. New York-traded foreign securities in the form of American depositary receipts account for only a fraction of the daily dealings in Deutsche Telekom AG, another of Europe’s largest stocks.

"There are exceptions, but in general, clients want to trade within the news cycle and when the home market is validating the price," says Gary Williams, head of European equity dealings at Goldman Sachs Group Inc. in London.

What might a global stock market look like? Frank Zarb, chairman of Nasdaq’s parent, the National Association of Securities Dealers, envisions a network of electronic markets free to trade stock issues listed on all of them on what will be one stock exchange that "follows the sun."

"Companies will be able to raise capital in other parts of the globe, and investors will be able to trade anywhere in the world," he says. "And you’ll see more of these changes than you might expect within three years."

Zarb is optimistic that regulatory differences among countries can be worked out. But not everyone is taking such an optimistic approach.

Though NYSE Chairman Richard Grasso says he recognizes that stock trading is "a global business" and that "the core 1,000 global companies will trade in multiple arenas," his talks with foreign markets will likely lead to alliances that trade only stocks already listed both on the NYSE and on a foreign market. This would avoid the registration problem.

The Big Board continues to attract big multinational stocks. Just last week, Swiss bank UBS AG said it would list there, while shares of Swiss drug giant Novartis AG began trading on the exchange.

Clark of First Boston, who predicts the number of world stock markets will dwindle to three or four, says that such large stocks might one day carry only "minimal" commissions and may even trade free. His firm is launching a trading desk, to be open from 5 a.m. to 8 p.m. New York time, just for trading of foreign tech and telecom stocks.

Gavin Casey, who will step down as Chief Executive of the London exchange after its merger with the Deutsche Boerse, sees nothing to stop the consolidation wave in Europe, both in trade processing and in trading platforms. But investors might not recognize the revolution right away. "We’re not going to get Microsoft trading around the clock immediately," he says.

Still, Casey adds, "It’s moving that way, and we needed to put down our markers early." (WSJ)