Refinitiv battle reveals unease over power of modern stock markets

LONDON STOCKONDON STOCK EXCHANGEVSEU:XCHANGE VS EU: Refi nitiv battle reveals unease over power of modern stock markets

Relations between London and Brussels have been be‚ er. While Brexit dominates the headlines, another cross-channel development has recently captured the a‚ enঞ on of fi nancial insঞ tuঞ ons. It concerns the the London Stock Exchange’s proposed US$27 billion (£21 billion) acquisiঞ on of US fi nancial company Refi niঞ v, into which the European Commission is carrying out an in-depth anঞ -trust invesঞ gaঞ on. With a ruling due in October, the commission is likely to reject the deal in its current form. To win approval, the LSE recently declared it was selling either the whole of Borsa Italiana or its bond-trading pla orm, MTS. Why does the EU care about the LSE’s acquisiঞ on of a US fi nancial data company? And why would the LSE sell the Italian stock exchange to quell these concerns? The answer lies in the fact that stock exchanges have transformed fundamentally over the last 25 years, as I demonstrated in a recent paper. This has largely gone unnoঞ ced and public percepঞ on clings to an outdated understanding of what exchanges are.

How exchanges changed

Stock exchanges are o[ en sঞ ll viewed as quasi-public marketplaces – icons embedded within naঞ on states and crucial for naঞ onal economic development. But they have in fact become powerful global corporaঞ ons which actively shape the development of capital markets around the world – with important implicaঞ ons for investors, companies and states. As an arঞ cle in The Banker put it a few years ago: “Until the 1980s, exchanges would … have been recognisable to a merchant who was trading in the 14th century – the ঞ me of their incepঞ on.” Exchanges used to be non-profit organisations, controlled by their members, with li‚ le agency of their own. They usually monopolised trading in their area, and were physical trading locaঞ ons, such as the Chicago Mercanঞ le Exchange, pictured below. This has changed in various ways. Financial liberalisation reforms such as the EU Investment Services Directive (1993) created competiঞ on between exchanges. No longer monopolies but a marketplace for marketplaces, they were forced to modernise and become more effi cient and customer-focused. Most demutualised and converted into listed companies. As one exchange official noted, they were now independent actors “fully in charge of their own desঞ ny”. At the same time, they also became profit-driven companies. The shi[ towards globalisaঞ on also meant more cross-border financial integration. Alongside the growing competitive pressures, there were opportunities to scale up, acquire competitors and venture into new markets. From Chicago to Singapore, futures exchanges started buying stock exchanges and vice versa, plus trading venues for bonds, carbon emissions and commodities. Former NYSE CEO John Thain had once observed that “every country has an army, a fl ag and an exchange”, but now exchanges were forming huge organisaঞ ons spanning the globe. Finally, exchanges turned from physical trading locations into financial technology companies. Faceto-face interaction on trading fl oors was gradually superseded by

electronic markets. The manager of one exchange noted in an interview: “We are of course known as a US exchange but that’s only about 10% of our revenue.” Digiঞ saঞ on had fundamentally changed the game as market technology, data and indices increasingly drove exchanges’ profi t. Exchanges are now actively creating, regulaঞ ng and shaping markets around the world. They control the very infrastructure of global fi nance - data, indices, fi nancial products, trading pla orms and clearing, essenঞ ally deciding how markets work for companies, investors and states.

Why LSE-Refi niঞ v ma‚ ers

A hierarchy has also emerged, with LSE one of a handful of global players that now dominate capital markets, along with CME, ICE, Cboe, Nasdaq and Deutsche Börse. These groups run the largest, most presঞ gious and profi table markets, and own the most important products, indices and technological know-how. While there are over 100 exchanges worldwide, these six companies account for over 50% of industry profits, and trading in stocks, futures and opঞ ons. LSE is now a central node in global and, importantly, European capital markets. It owns FTSE Russell, one of the leading index providers that steer investments by deciding which companies and countries are included in the indices tracked by global investors - essentially acting as a gatekeeper for global fi nance. LSE owns LCH Clearnet, the world’s largest clearing house. Clearing houses act as middle men (or central counterparঞ es) between buyers and sellers in trades to transfer money and assets back and forth and act as guarantors for each transacঞ on. They require investors to put up collateral, whereby clearing houses basically decide which assets they deem safe enough to back fi nancial transactions. During the eurozone crisis, for instance, these signifi cantly impacted countries’ refi nancing operations as some government bonds were no longer deemed safe. LSE also owns several European trading pla orms for stocks, bonds, derivaঞ ves and exchange-traded funds – including Borsa Italiana and with it the MTS pla orm. As Bloomberg recently noted, MTS is a criঞ cal piece of European bond-market infrastructure with average daily trading volumes exceeding €100 billion (£90 billion). It is a key venue for trading Italian and other European countries’ government debt. Refinitiv (previously the fi nancial unit of Thomson Reuters) owns Tradeweb, an even larger bond-trading pla orm. Together with the MTS bond trading pla orm, FTSE Russell’s bond indices and LCH collateral rules, LSE’s acquisition of Refinitiv would have created a quasi-monopoly in the European government-bonds trading infrastructure. With European sovereign debt already highly poliঞ cised in recent negoঞ aঞ ons on the EU’s coronavirus recovery fund, an insঞ tuঞ on with the power to shape this market that will probably be outside of the EU’s regulatory reach come December is hardly acceptable for EU regulators. The EU already blocked a proposed merger between LSE and Deutsche Börse in 2017 for similar reasons. With the threat of LSE’s market dominance averted, the EU might allow the LSE-Refinitiv deal to go through a[ er all. But what this episode demonstrates is that as crucial building blocks of global fi nance, exchanges have become important counterparts to states. What they own and what decisions they make have become ma‚ ers of internaঞ onal poliঞ cal importance – and has added an extra layer of complexity for governments trying to set the rules for global fi nance.