The London Stock Exchange’s acquisition of Borsa Italiana increasingly looks like a marriage between two partners who really need each other.
The LSE, wildly successful in its core cash equities market, has never managed to diversify into more competition-resistant businesses such as derivatives. As a result of a badly-botched effort to develop a clearing business nearly two decades ago, it has no earnings from post-trading services to diversify its revenue stream.
And although its share price has risen strongly on growth in its underlying cash equities business – helped along the way by persistent speculation of yet another bidder waiting in the wings – analysts say that it cannot build a business around a strategy of just saying “no” to suitors.
Indeed, analysts noted that although this deal makes sense in strategic terms, it may come as a disappointment to some shareholders who bought the shares believing a suitor was just around the corner.
“While this is value-enhancing for shareholders, it reduces the probability of a takeover by Nasdaq [its 30 per cent shareholder],” said Mamoun Tazi, exchanges analyst at Man Securities.
The Borsa has a presence in cash equities, derivatives and bonds, not to mention clearing and settlement. But it is one of Europe’s smaller markets and, insiders say, its own equities electronic trading platform is not fully compliant with new European regulations aimed at promoting competition, known as MiFID.
Bankers say that as recently as last year Borsa officials were insisting MiFID would not affect them. However, on Monday Borsa insisted that the system was fully prepared for MiFID.
Competition also remains a serious issue for all exchanges, especially smaller ones.
Borsa insiders have agonised for months about possible competition both from other European exchanges and from a challenge to the region’s existing exchanges that is set to come from the new “Project Turquoise” initiative being developed by a consortium of seven large investment banks .
These have vowed to build their own low-cost, high-speed competitor. It is understood the group now has a short-list of three possible technology providers. OMX, the Nordic exchanges group that as agreed to be acquired by Nasdaq, is in the lead.
In setting out their mutual rationale for the deal, the chief executives of the LSE and Borsa Italiana pointed on Monday to cost synergies of at least £20m ($40m) by 2010 of an unspecified nature. The two groups agreed that the LSE’s high-speed TradElect platform, which is fully MiFID compliant, should be the group’s trading platform.
The LSE has also promised to export its Aim small-companies model to Italy. Discussions with regulators on that point are ongoing.
Most strikingly, perhaps, Clara Furse, the LSE’s chief executive, has backed away from her disavowal of the “vertical silo” of rival exchanges, where post-trading services are bundled into the trading platform. The Borsa deal sees her embrace the chance to earn revenue from that source. Ms Furse said because the Borsa had signed a code of conduct promising to link its post-trade system with those of competitors, there was no barrier to competition.
The LSE sees further scope for expanding the Borsa’s derivatives business, which currently accounts for only 7 per cent of revenues. Italy, in common with several other Continental centres, boasts large volumes of retail investors in its derivatives market – in stark contrast to the UK.