2009: London awakes from turmoil

A New Year's column from a decade into the future.

IN THE beginning was the word. And it was good. It was their bond. Jobbers made money, the London Stock Exchange triumphed, and investors paid. Then came the Big Bang. This revelation brought a new world, full of automation, of capturing continental Europe's trading, and of selling traditional dealing firms at inflated prices. Now, after a period of doubt about the value of financial services, and at the start of this ninth year of King William's reign in 2009, belief in the London Stock Exchange has been rekindled.

The Exchange is not what it once was. Of the seven functions it delivered historically, only one remains. It no longer provides a trading system. Microsoft does. The Microsoft Exchange was the culmination of a veritable cult of new dealing mechanisms operated on a for-profit basis by private firms. These offered lower costs than the old, national exchanges, and allowed traders to enter non-traditional types of orders, rather than the simple buy and sell limit orders.

With the passing of the London Stock Exchange as a trading system, its role as a source of price and quotation also disappeared. Since the Wall Street disaster of 2001, clearing and settlement have been deemed too important to leave to the market. Lobbying and competition between the rating agencies allowed them to capture the listing function. And the provision of company news was long ago appropriated by the data vendors. So the Exchange operates today solely as a regulatory body, subsidised by Microsoft as a gesture of good faith.

The path to where we are now has been one of evangelism, scission, reformation and salvation. A series of false visions for the European capital markets have been successively proposed, preached, and finally denounced. The first attempt at co-operation between European stock exchanges took place in the late 1970s. The InterBourse/Stock-Exchange Data Information System (IDIS) project was abandoned because at the time exchanges did not have the computer technology to make the goal operational.

The Pipe (Price and Information Project for Europe) was launched in 1989, again to pursue the creation of an inter-European information network. By 1990, Pipe's name had been changed to Euroquote, and the goals of the project had widened. Many hoped to develop Euroquote into a trading system; some even wanted to integrate settlement functionality into the system. Conflict between the participating exchanges, however, rapidly led to a fractious dissolution of the linkage.

In the mid 1990s, Paris attempted to convert the rest of Europe via a proposed Franco-German linkage. The transparency of its intended dominance quickly led to failure. In the late 1990s, Germany and London made an attempt with different intentions, but the same result. The initial success of the association was dependent on the fact that only the two exchanges had to work with each other. However, this attracted many other European exchanges to join the scheme, and agreement between the multitude of national exchanges once again proved impossible to implement. It was only after Disney attempted to enter the market for markets, that Microsoft subsumed trading facilities into its operating system.

The present structure of the Exchange has not significantly affected the way in which the key types of participants do their business. The demise of the intermediary, frequently reported before the millennium, materialised quickly afterwards. Since 2K, the identities of the five banks that have dominated capital-raising in Europe have not changed. If they can be said to have a nationality, it is probably American: most are listed on the New York Stock Exchange, and most have their headquarters in New York.

The management of information has become the key factor to investors' success, given the data overload that they face. This, in turn, has had two critical implications for the success of fundraisers. To even be considered now, information about any investment opportunity has to be able to worm its way through the multitude of filters and search engines that investors and their technology advisers have created to protect themselves. The marketing of an investment opportunity has thus had to remain as important as the investment on offer.

As for the issuers, aggressive competition in the industrial world has led to increasing consolidation in all the major economic sectors of Europe. The number of serious issuers has thus shrunk again. Equity has become a progressively smaller source of financing for the big industrial companies as they have financed their activities through retained profits. Most importantly, the fees paid for borrowing have also diminished, given the increasing commoditisation of the major companies' borrowing strategies.

The fact that the London Stock Exchange is only a regulator now does not mean that its difficulties have disappeared. On the contrary, the public's demand for solutions to unmanageable problems has increased their expectations. The decline in the number of major banks, the increased probability that problems in one of them may have serious macro-economic effects and the general decrease in savings have all meant that the role of the regulator is perceived to be even more vital today than in the past. However, the international reach of the dominant financial players, the lack of any European agreement on regulatory sharing and the increasing acceptance of a general lack of understanding of how markets work all mean that a regulator simply cannot realise the masses' convictions. Those who are wise await with trepidation the final unmasking of the regulators as false prophets.

Let us pray that we have a prosperous year in 2009 - and one in which the London Stock Exchange, after a decade of turmoil, finally finds a degree of stability.

Ruben Lee is the director of the Oxford Finance Group, and author of 'What is an Exchange? The Automation, Management and Regulation of Financial Markets'.

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