Francois-Eric Perquel

From our European Bureau: The Times They Are A-Changin'

Europe is experiencing a number of dramatic changes in its economic structure. The result is that the terrain for continental investors is shifting radically.

The most obvious change is the introduction of the euro, which is due to be finalized in January of 2001, when the national currencies across euro-land will cease to exist. Partly as a consequence, other important changes in the financial sector are occuring, though they have gone largely unnoticed.

The current trend of European financial markets either merging or building common platforms should have a strong effect on institutional investments. In the mid 90s, the failure of Easdaq to become a truly pan-European market showed that investors and their intermediaries were not yet ready for such a market.

The situation has changed, however, and globalization is increasingly pushing issuers to look more at a market's liquidity and brand name than its geographic location. This is the reason European stock exchanges have started merging in a bid to become more competitive vis-à-vis the U.S. stock markets. In addition, with increased equitization in Europe, large institutional investors increasingly need markets with the liquidity to meet their orders and facilitate cross-border trading.

The spate of merging activity only began in earnest in the year 2000. In March, the Paris, Amsterdam and Brussels stock exchanges decided to merge within Euronext. By May, the London and Frankfurt exchanges had made an effort to form an alliance in a new market called the iX. This venture was hailed at the time as the future continental stock exchange by many analysts. Afterall, it included two of the three largest European markets, and various other markets had declared their interest in entering it. The problems iX faced in actually getting off the ground coupled with the late 2000 failure of the Swedish OM's audacious bid to buy out the London Stock Exchange (LSE) spelled doom for the iX exchange. Even though other deals are in the works (including virt-x, a planned alliance between the Swiss stock exchange with Tradepoint), the only success to date has been Euronext. Euronext has been aggressive in its expansion efforts, launching a project called GEM (Global Equity Market) in June 2000 and also forging an partnership with the American Stock Exchange this year to cross-list exchange-traded funds (ETFs). Because it stands alone as the only successful coordinated effort among European exchanges, Euronext is the best case to analyze whether such ventures bring increased liquidity, trading ease and branding to the table.

According to the statistics of the three main European stock markets, since its inception, Euronext increased its partners' trading increased by 2.66%. This compared favorably with a slight decrease of volume in the London Stock Exchange and a decrease of more than 35% in trading on the Deutsche Börse (DB). Nonetheless, it is still difficult to conclude with any certainty that the merger has improved liquidity. Other factors may have been more important. The decrease of the volume in the DB, for example, may have been partially a side effect of the recent fall in price and decline in interest in the technology sector. The small increase of the Euronext volume may have been the result of the introduction of ETFs (trackers). It is possible that the merger of the Paris, Brussels and Amsterdam markets has succeeded in liquidity in an adverse environment, but it is still too early to be sure.

The improvement in the ease of transaction is more clear-cut. Euronext has a unified trading (the NSC) and settlement (Clearnet21) system. This enables a gain in efficiency that has noticeably decreased costs. Euronext boasts that the total cost reduction generated by the merger amounts to 50 million euros, but it is not clear what this figure includes. In any case, there has been a strong reduction of cost simply in having to maintain and update one set of trading systems instead of one per country. In terms of image, the situation is even clearer even if it is not yet fully recognized by the market players, the majority of whom are based in London.

Euronext is the biggest stock market on the European continent with more than one thousand six hundred companies listed and a total capitalization of more than 2.4 trillion euros and a monthly average volume of 142 billion euros at the end 2000. In summary, the example of Euronext shows that stock exchange concentration can lower transactional costs, improve brand awareness, and possibly bring improved liquidity. Not all institutional players are fully sold on Euronext liquidity, however, and many of them continue to trade blocks OTC or through ECNs. They participate in these markets because they are structurally far less expensive than traditional stock exchanges. These parallel markets have the side effect of removing liquidity from the primary markets and pushing stock markets toward new mergers due to competition for better prices and greater liquidity. A great evolution of European markets has only begun to unfold.

François-Eric Perquel is the author of the book Eastern European Financial Markets, and is currently based in Barcelona, Spain. Mr. Perquel has held several important positions within the European financial community, including service as an independent consultant during the establishment of Easdaq.