LSE has defied expectations to go from prey to predator

Asked to pick one of the winners in financial services a decade ago, it is unlikely that many would have nominated a stock market at all — let alone London Stock Exchange, the City of London’s traditional share-trading hub.

Recently demutualised, possessed mainly of a utility cash equities business seen to be vulnerable to competition and an indifferent reputation for technology, most observers expected LSE to be swallowed in the first wave of consolidation after national bourses became shareholder-owned corporations.

Over several years, the British group has fended off bid after bid from deal hungry rivals such as Deutsche Börse , America’s Nasdaq and even the smaller Swedish exchange, OMX. The onslaught abated only when the crisis finally struck.

Eight years on, however, what was prey has been transformed into a hungry predator. Now the world’s fifth-largest exchange group by market capitalisation; the $13bn company is expanding fast through acquisition. The shares are trading a third above their pre-crisis peak.

That is startlingly better than most exchanges, or indeed banks, in the post-crash period. Deutsche Börse, for instance, still trades well below its pre-2007 high point. Only the fast-growing US exchange, ICE, has seen its shares shoot up with more dispatch.

Like many an unfashionable business before it, LSE has sought to revive itself through reinvention. Over the past five years, the group’s chief executive Xavier Rolet has transformed its structure.

The most striking change has been the dilution of the stock market utility — in essence the capital markets and trading operations. Since 2010 this has fallen from about half of group revenues. It now stands at just 25 per cent.

Instead LSE has sniffed out faster growing areas for expansion, taking advantage of the trend for post-crisis regulation.

Forced by regulators both to shunt more risk off their balance sheets, banks have started clearing more derivatives through central counterparties and selling their stakes in the institutions that conduct these transactions. This development has allowed LSE both to acquire a majority stake in one of Europe’s largest clearing houses, LCH.Clearnet, and to wring from it some impressive growth.

Mr Rolet has also diversified by building LSE’s index operation, first purchasing the 50 per cent the group did not own of FTSE and then paying $2.7bn for Russell of the US — owner of the Russell 2000 index.

Indices may sound almost as workaday a business as running an equity market, but they allow the group to tap into the increasing global trend among savers to buy passive fund management products and exchange traded funds — the promoters of which must, by and large, pay to license an index to act as an all-important benchmark. ETFs alone have assets of some $2.3tn worldwide and are growing at some 15 per cent per year, according to Ernst & Young.

Mr Rolet’s diversification comes at a time when many stock market owners are admitting that the sector’s initial obsession with cross-border consolidation has proved unsuccessful.

For all the modern technology, this remains predominantly a local business. Apart from a few special cases such as technology businesses, companies tend to default to their home market when they seek to list their shares. Cross-border synergies are consequently very hard to find.

Some international deals have even started to be unpicked. When ICE took over NYSE Euronext two years ago, it spun off the European equities business altogether.

Mr Rolet has not gone so far — yet. But a sceptic might reasonably wonder what now glues the group together. It is far from clear how much the international indices operation or the clearing house gain from sitting alongside a stock market.

Of course there are plenty of reasons for Mr Rolet to stick with what he has. Buying expensive assets in fashionable sectors is always risky. There is the chance that the growth anticipated will not come through. Keeping the core stock market business is a hedge against his diversification strategy going awry.

But the wider risk is that through dwindling management attention, this crucial piece of financial infrastructure becomes progressively an orphan asset. LSE’s share of UK equity trading has fallen sharply in recent years and now stands at a little over 50 per cent. Only a few years ago it was the entire market.

Keen to wring cash from their technology investments, LSE and the new trading venues and dark pools it competes with are increasingly focused on large, widely traded stocks. That may be the right course for Mr Rolet and his investors.

But for policy makers worrying about access to capital and smaller businesses looking to raise debt and equity, it may leave a hole to be filled.

jonathan.ford@ft.com