Lessons from the recent stock exchange merger activity

Journal of Competition Law and Economics

Volumn 4, Issue 3, 2008, Pages 837-869

  Kokkoris, Ioannis ^a,b   Olivares Caminal, Rodrigo ^c  

^a United Kingdom Competition and Markets Authority   (United Kingdom)

^b CITY UNIVERSITY   (United Kingdom)

^c UNIVERSITY OF WARWICK   (United Kingdom)

Author keywords

[No Author keywords available]

Indexed keywords

EID: 54049146734     PISSN: 17446414     EISSN: 17446422     Source Type: Journal    
DOI: 10.1093/joclec/nhn002     Document Type: Review

References (95)

1. Council Directive 93/22EEC. The Investment Services Directive (ISD) set the legislative framework for investment firms and securities markets in the European Union (EU), providing for a single passport for investment services enabling investment firms to operate throughout the EU. The ISD has been repealed by the Markets in Financial Instruments Directive (MiFID) of the European Parliament and of the Council of April 21, 2004 (2004/39/EC).
2. 2004/39/EC. MiFID was adopted in April 2004 and its implementing measures in August 2006. EU member states had until January 31, 2007 to incorporate MiFID and its implementing measures into domestic legislation and rules. MiFID came into effect on November 1, 2007 and replaced the existing ISD.
3. Member States that implemented ISD can guarantee their investment firms freedom of establishment and freedom to provide services in other EU states.
4. The key features of MiFID can be summarized as: (1) it will retain the "passport" principle contained in the ISD broadening the scope of "core" investment services; (2) it will introduce the concept of "maximum harmonization," which focuses on "home" state supervision in lieu of "minimum harmonization/mutual recognition," which was the previous applicable criterion; (3) the abandonment by certain Member States of the so-called "concentration rule," which obliges firms to route all client orders through regulated exchanges; (4) new pre-and post-trade transparency requirements for equity markets; (5) a more extensive transaction reporting requirement; and (6) most firms falling under the scope of the MiFID will have to comply with the Capital Requirements Directive (2006/48/EC).
5. M. Clayton, B. Jorgansen & K. Kavajecz, "On the Formation and Structure of International Exchanges," AFA 2001 New Orleans; NYU Ctr for Law and Business Research Paper No. 00-08; RLW Center Working Paper No. 22-99 (2000).
6. S. Ramos, "Competition Between Stock Exchanges: A Survey" (2003); http://www.swissfinanceinstitute.ch/rp77.pdf, at p. 6 (accessed May 15, 2007).
7. Directive 2003/6/EC of the European Parliament and of the Council of January 28, 2003 on insider dealing and market manipulation (OJL 096, April 12, 2003, pp. 0016-0025).
8. Directive 2003/71/EC of the European Parliament and of the Council of November 4, 2003 on the prospectus to be published when securities are offered to the public or admitted to trading under Directive 2001/34/EC (OJL 345, December 31, 2003, pp. 0064-0089).
9. Directive 2004/109/EC of the European Parliament and of the Council on the harmonization of transparency requirements with regard to information about issuers whose securities are admitted to trading on a regulated market and amending Directive 2001/34/EC (OJL 1 390/38, December 31, 2004).
10. Directive 2006/49/EC of the European Parliament and of the Council of June 14, 2006 on the capital adequacy of investment firms and credit institutions (recast).
11. IOSCO, together with the Basel Committee on Banking Supervision and the International Association of Insurance Supervisors, constitute the Joint Forum of International Financial Regulators.
12. The General Agreement on Tariffs and Trade was part of the Bretton Wood's enginery with the aim of reducing barriers to international trade and fostering - together with the other measures adopted at the time - recovery after World War II.
13. The General Agreement on Trade in Services (GATS) resulted from the Uruguay Round negotiations and entered into force in 1995. It is a treaty of the WTO to extend the multilateral trading system of the GATT to services.
14. The term "competition law" also covers what in the United States is referred to as "antitrust law."
15. From a competition standpoint, stock exchange mergers may have a severe impact on the competition among stock exchanges and thus lead to higher fees and/or lower quality of service.
16. Horizontal mergers are mergers between parties that operate in the same relevant market. Such mergers can increase the market power of the merging firms so that they could unilaterally impose a profitable postmerger price increase. Other firms in the market might raise their prices in response, also unilaterally. Thus, rivalry might weaken. Moreover, a horizontal merger may increase the likelihood of (and/or stability and sustainability of) collusion, either tacit or explicit, between the remaining firms in the market.
17. Vertical mergers are mergers between parties that operate at different levels of an industry. Such mergers, though often procompetitive, may in some circumstances reduce competitive constraints faced by the merged firm as a result of increased barriers to entry, increased rivals' costs, substantial market foreclosure, or increased likelihood of collusion. This risk is, however, unlikely to arise except in the presence of existing market power or in markets where there is already significant vertical integration as well as vertical restraints.
18. No vertical issues in any relevant market will be addressed in this paper. However, note that vertical issues have been addressed to some extent in detail in the U.K. Competition Commission report titled "Deutsche Börse AG, Euronext NV and London Stock Exchange p1c, A Report on the Proposed Acquisition of London Stock Exchange plc by Deutsche Börse AG or Euronext NV," dated November 2005 ("Competition Commission Report").
19. In this article, stock exchange mergers will refer to cross-border stock exchange mergers.
20. Competition Commission Report, at paragraph 2.11.
21. See further: http://www.omxgroup.com/omxcorp/ (accessed May 10, 2007).
22. Subject to their debt-to-equity ratio, corporations have to decide if they are going to finance themselves with debt or equity. The debt-to-equity ratio measures the amount of money that can be borrowed in the long term and is calculated by dividing the total liabilities by the equity of the company. The result of this equation is the percentage of the company that is indebted or leveraged. Tle normal level of debt-to-equity has changed over time, and depends on both economic factors and society's general feeling towards credit. It also is dependant on the industry. Any company that has a debt-to-equity ratio of over 4-5 percent should be looked at more carefully to make sure that there are no liquidity problems. For further details on the practical side of debt-to-equity ratio, see Jack S. Levin, Structuring Venture Capital, Private Equity and Entrepreneurial Transaction (Aspen Publisher, 2000).
23. Competition Commission Report, at paragraph 4.7.
24. Competition Commission Report, at paragraph 4.9.
25. Competition Commission Report, at paragraph 5.27.
26. K. R. French & J. M. Poterba, "Investor Diversification and International Equity Markets," 81 American Economic Review 222 (1991).
27. Norman Strong & Xinzhonh Xu, "Understanding the Equity Home Bias: Evidence from Survey Data," Review of Economics and Statistics (2002), in S. Ramos, "Competition Between Stock Exchanges: A Survey" (2003), p. 6; http://www.swissfinanceinstitute.ch/rp77. pdf (accessed May 10, 2007).
28. T. Gehrig, "An Information Based Explanation of the Domestic Bias in International Equity Investment," 21 The Scandinavian Journal of Economics 97 (1993).
29. H. Hau, "Location Matters: An Examination of Trading Profits," 56 Journal of Finance 1959 (2001).
30. B. Biais, "European Stock Markets and European Unification, in European Markets with a Single Currency" (Jean Dermine & Pierre Hillion, eds., Oxford University Press, 1999).
31. D. Jean Pierre, R Giavazzi & E.-L. Von Thadden, "European Financial Markets after EMU: A First Assessment," CEPR 2413 (2000).
32. The OFT is the first-phase competition authority for the assessment of mergers. If the OFT believes that it is or may be the case that the merger has resulted in or may be expected to result in a substantial lessening of competition (Enterprise Act paragraph 22), the OFT refers the merger to the Competition Commission, which will conduct a more thorough investigation of the likely adverse impact of the merger on competition.
33. NYSE/Euronext, September 2006, www.oft.gov.uk (accessed April 25, 2007).
34. That may not be true in all cases, but is likely to be true in jurisdictions within the EU, United States, Japan, and Australia.
35. Competition Commission Report, at paragraph 5.34. The implementation of the EU Prospectus Directive (2003/71/EC) in July 2005, with its introduction of the "passport" mechanism that allows companies listed on an EU "regulated market" to make offers across the EEA with a single prospectus approved by the company's home Member State competent authority has, in conjunction with improvements in the efficiency of cross-border securities trading, largely obviated companies incorporated in EU Member States to seek secondary listings on an EU exchange other than their home exchange.
36. Another factor that should be taken into account is that the vast majority of traded shares are at the exchange on which companies are primarily listed.
37. Trading costs can be classified as direct (or explicit) and indirect (or implicit) trading costs. Direct costs include broker commissions and exchange and other fees; indirect costs relate to effective spreads, that is, the difference between the price of a trade and the midpoint of the best-quoted bid and ask prices, just before the trade. The indirect component includes costs and risks associated with the immediacy or ability to trade without delay. See further
38. OXERA, "The Cost of Capital: An International Comparison" www.oxera.co.uk (accessed May 18, 2007) ("OXERA").
39. OXERA, p. 35.
40. OXERA.
41. A regional geographic frame of reference for secondary listings was also identified by the OFT in Anticipated Merger between NYSE Group, Inc. and Euronext N. V., October 12, 2006.
42. Competition Commission Report, at paragraph 4.14.
43. J. L. Cochrane, J. E. Shapiro & J. E. Tobin, "Foreign Equities and U.S. Investors: Breaking Down the Barriers Separating Supply and Demand," Stanford Journal of Law, Business & Finance 241 (Summer 1996).
44. M. Pagano, A. A. Roell & J. Zechner, "The Geography of Equity Listing: Why Do Companies List Abroad?" CSEF Working Papers 28, Centre for Studies in Economics and Finance (CSEF), University of Salerno, Italy, revised December 1, 2000.
45. Pub. L. No. 107-204, 116 Star. 745, July 30, 2002, also known as the Public Company Accounting Reform and Investor Protection Act of 2002.
46. Speech by SEC Commissioner: Remarks Before the 4th Annual Financial Services Conference by Commissioner Paul S. Atkins; http://www.sec.gov/ news/speech/spch013106psa.htm (accessed April 20, 2007).
47. Ernst and Young, Accelerating Growth, Global IPO Trends 2006; http://www.ep.com (accessed April 20, 2007).
48. These include China Construction Bank (CCB), which raised U.S.$9.2 billion; China Shenhua Energy, which raised U.S.$3.3 billion; and Bank of Communications, which raised U.S.$2.2 billion.
49. Competition Commission Report, at paragraph 2.4.
50. Competition Commission Report, at paragraph 4.55.
51. The Competition Commission Report has a detailed analysis of off-exchange trading.
52. Financial Times report on World Exchanges, November 28, 2006; http://www.ft.com ("FT Report") (accessed April 20, 2007).
53. FT Report.
54. FT Report.
55. Trades generated electronically based on very small movements in share prices.
56. FT Report. Please note that Mr. Concannon is NASDAQ's vice-president.
57. According to MiFID, there are no requirements in individual member states to trade through a regulated exchange. MiFID may encourage a variety of potential competitors entering the market.
58. FT Report.
59. Citigroup, Credit Suisse, Deutsche Bank, Goldman Sachs, Merrill Lynch, Morgan Stanley, and UBS.
60. See, e.g., "Search Starts for Chief Executive to Run Rival Exchange," The Independent, January 13, 2007.
61. Competition Commission Report, at paragraph 4.17.
62. The FSA has recognized and supervises a number of Recognized Investment Exchanges (RIEs) and Recognized Clearing Houses (RCHs) under the Financial Services and Markets Act 2000. Recognition confers an exemption from the need to be authorized to carry on regulated activities in the U.K. To be recognized, RIEs and RCHs must comply with the recognition requirements laid down in the Financial Services and Markets Act 2000 (Recognition Requirements for Investment Exchanges and Clearing Houses) Regulations 2001. RIEs include EDX London Limited, ICE Futures, LIFFE Administration and Management, London Stock Exchange p1c, NYMEX Europe Limited, The London Metal Exchange Limited, and virt-x Exchange Limited.
63. R. Ahdieh, "Making Markets: Network Effects and the Role of Law in the Creation of Strong Securities Markets," 76 Southern California Law Review 277 (2003), at p. 333.
64. Source: World Federation of Exchanges; http://www.world-exchanges.org/ WFE/home.Asp?nav=ns6 (accessed June 24, 2007).
65. Competition Commission Report, at paragraph 5.18.
66. This small amount of the stock issued on secondary listings on many occasions is less than 5 percent of the issued stock. Because the "secondary" is likely to have a small proportion of the listed shares of the company, the competitive constraint between the "primary" and "secondary" exchange is likely to be insignificant.
67. The exchange where the primary listing is.
68. The exchange where the secondary listing is.
69. Institutional investors represent 70-80 percent of NYSE average volume traded. See further S. Ramos, "Competition Between Stock Exchanges: A Survey" http://www.swissfinanceinstitute.ch/rp77.pdf (2003), p. 19.
70. Competition Commission Report, at paragraph 5.59.
71. Competition Commission Report, at paragraph 5.60.
72. Towards the exchange's customers (for example, banks, etc.)
73. N. Economides, "Economics of Networks," 14(2) International Journal of Industrial Organization 7 (1996).
74. Competition Commission Report, at paragraph 5.38.
75. Competition Commission Report, at paragraphs 5.64-5.71.
76. Competition Commission Report paragraph 5.80.
77. As regards bonds, this paper will focus on the listing and trading of bonds rather than on post-trade services related to bonds.
78. See H. Scott & P. Wellons, International Finance: Transactions, Policy and Regulation, 939 (Foundation Press, 8th edn).
79. This is also confirmed by the Competition Commission Report, at paragraph 2.4.
80. Competition Commission Report, at paragraph 4.60.
81. Notwithstanding that a complete competition analysis may illustrate different dynamics in competitive choices.
82. OFT, Proposed Acquisition by Euronext NV of LIFFE Holdings plc, December 21, 2001.
83. Competition Commission Report, at paragraph 4.60.
84. Competition Commission Report.
85. The data of tables was obtained from the World Federation of Exchanges; http://www.world-exchanges.org/WFE/home.Asp?nav=ie (accessed June 22, 2007). The percentages have been calculated based on the total value of trading on all exchanges that a particular derivative is traded at.
86. M. Malkamaki, "Economics of Scale and Implicit Mergers in Stock Exchange Activities" (2000), at p. 25; http://fmg.lse.ac.uk/upload_file/40_malkamaki.pdf
87. B. Steil (ed.), The European Capital Markets: The state of the Union and an Agenda for the Millennium (The Royal Institute of International Affairs, London, 1996).
88. S. Ramos "Competition Between Stock Exchanges: A Survey" (2003), http://www.swissfinanceinstitute.ch/rp77.pdf, p. 26 (accessed March 28, 2007).
89. Competition Commission Report, at paragraph 4.61.
90. Competition Commission Report, at paragraph 5.59.
91. Stock exchange mergers may have both positive and negative effects on technological advancement. A positive impact involves economics of scope in innovation, whereas the negative impact may include less incentive to innovate, as well as limited ability for competitors to enter the market. An additional essential factor for competition is the post-trade services. Without a unified post-trade system users need to net positions against each other, incurring higher costs. However, as mentioned in the introduction of this paper, post-trade services are outside the scope of this paper. Thus, no further analysis will be provided. The Competition Commission Report provides a detailed account of the likely impact of mergers on post-trade services.
92. Assuming that each type of derivative constitutes one separate product market, a reasonable assumption to make.
93. An indicating factor of likely concern may be the market share of the postmerger entity. However, market shares as well as concentration ratios can only provide an initial indication as to the effects of the merger and are not conclusive. In this particular case, market shares may not be a good direct indicator of the market power of exchanges because they will, to a great extent, simply reflect the relative size of the capital markets associated with each exchange.
94. London Economics, "Quantification of the Macro-Economic Impact of Integration of EU Financial Markets" http://ec.europa.eu/ internal_market/securities/docs/studies/summary-londonecon_en.pdf, p. i (accessed April 13, 2007).
95. R. Abrams & M. W. Taylor, "Issues in the Unification of Financial Sector Supervision," IMF Working Paper No. 00/213, 2000, p. 27.