30 July 2019

The London Stock Exchange is turning away from Europe and endorsing Global Britain


Investing in stocks has been popular since the forerunners of Starbucks became the epicentre of investment in the likes of Antwerp and Amsterdam when funding explorations into the new world was all the rage. In 1698 one John Castaing began posting the prices of stocks in Jonathan’s coffee shop and the Change Alley emporium gave birth to the London Stock Exchange.

Mutually owned member-driven stock exchanges have in recent times given way to for-profit entities, driven by a digital process of “Capital Market Revolution!” which took hold during the late 1990’s as network technologies such as the worldwide web enjoyed their early bubble phase.

Since that time, not only have many once sleepy exchanges  become merely the platforms for dealmakers to invest, trade and arbitrage but indeed the market structure has itself been a hugely speculative hotbed for investors.

The London Stock Exchange was a relative latecomer to the dealmaking frenzy but it has regained ground during the past decade, transforming from a largely monoline share market into a form of department store similar to competitors such as Hong Kong and Nasdaq.

Dame Clara Furse began the process, after seeing off various bidders, by acquiring Milan’s Borsa Italiana in 2007. Her successor, Xavier Rolet then followed a fairly frantic path, acquiring a variety of assets, perhaps most notably the Russell Index business and a majority stake in LCH Clearnet (in 2012).

The latter was an inspired purchase, as it helped the LSE fill a vital product gap in derivatives. Since before the turn of the century it has been obvious that while stock markets are a pleasant annuity business, the serious growth is in futures, options and so on. Generations of poor foresight still leave LSE lacking in the derivatives field but LCH is a jewel in an area where growth has invariably outpaced cash markets.

LCH, the London Clearing House, is a fascinating business: a key central repository of risk for major derivatives contracts. Thanks to visionary leadership in the 1990s, LCH has cemented itself as the epicentre of swap-trade clearing contracts in no less than 26 different currencies. In a post-referendum fit of protectionist pique, the EU has vainly made economically illiterate efforts to remove the Euro from this basket – an act of fiscal vandalism which endangers the Euro more than it threatens London’s financial centre.

During the crypto-socialist era of Theresa May’s ‘government’ the folk who most robustly defended the LSE Group’s clearing interests were in Washington DC. Christopher Giancarlo, chair of the CFTC derivatives regulator, made clear that protectionist instincts restricting the free flow of Euro-denominated business would be deemed a hostile act by the USA.

Perhaps partially inspired by that American defence of a key asset, the London Stock Exchange under a new CEO, New Yorker David Schwimmer, has pivoted significantly towards the US. At the weekend rumours were confirmed by LSE that the exchange is looking at a transformational merger with Refinitiv, an uninspiring brand name redolent of a haemorrhoid cream. The business formerly known as Thomson Reuters financial was acquired by private equity firm Blackstone last year.

At the core of the rationale for this merger is the dizzying expansion of demand for financial data. As the analogue world has given way to the digital, the ability to calculate, correlate, save and distribute data has abounded. The replacement of floor markets with screen-based electronic markets has allowed a huge amount more data capture which can be cost-effectively stored in ever-expanding memory banks, while networking has enabled rapid transfer.

Market volumes have exploded too, thanks to the low-cost efficiency of digital market facilitation. To put it in perspective, essentially financial markets now produce more data annually than all markets generated from the foundation of ancient Phoenicia in 2500 BC through to the year 2000.

With pointy-headed mathematicians aplenty at all manner of financial research houses, the desire for data is growing exponentially. Even those with a simpler approach to financial analysis are seeking ever more ways to look at data: on cellphones, tablets and laptops where 30 years ago the prices were largely contained in the financial pages of printed newspapers and those data vendor terminals.

Financial data has always been prized where it is delivered promptly and efficiently. In the 19th century major investors sent representatives to observe major battles from the sidelines. Carrier pigeons were swiftly despatched after the last shot was fired to deliver the result in what was then the ultimate in low latency. Nowadays, the ability of computer processors following Moore’s Law of expansive capacity means investors’ demand for data has become almost insatiable.

Thus the potential combination of the London Stock Exchange with Refinitiv looks fascinating. Exchange deals have often deployed the “merger of equals’ tag where the realpolitik has been the ruthless swallowing whole of a rival. In the case of LSE-Refinitiv, the two businesses appear to be somewhat equally valued (LSE $25 billion, Refinitiv $27 bln) creating a group via an all-share transaction of a similar size to InterContinental Exchange, which owns the New York Stock Exchange but, like the world’s largest market structure CME Group, derives most of its revenue from derivatives trading.

Refinitiv has some 200,000 financial terminals sitting on the banks of many of the world’s professional investors, with each terminal costing a minimum of $20,000 a year. Apart from being a welcome quasi-annuity for cash flow, it is also vital screen real estate.

The Eikon terminal can be easily transformed from receiving data to a two way dealing instrument whereby investors can route their orders straight to LSE operated markets, amongst others. Equally, the Refinitiv business has useful assets in markets (US bonds – Tradeweb) and foreign exchange (FXAll) where LSE Group is currently not significantly positioned.

Coincidentally, the Deutsche Boerse was until recently negotiating to buy the FXAll platform before news of LSE seeking to swallow Refinitiv whole emerged. DB1 and LSE have had a history of unsuccessful coupling efforts. As recently as 2016 a fatally flawed plan was dubbed the “merger of equal desperation”, as there was no plausible way for such a combination to pass EU antitrust laws.

At the time this deal suggested management in London and Frankfurt seemed to have lost their perspective. When Brussels nixed the deal on antitrust grounds a year later, it signalled the end of an era – exchange megamergers needed to operate in a different field as regulators were uncomfortable with the consequences of massive market concentration in key instruments.

Thus LSEG wooing Refinitiv is at once a big data play and a significant new move in the “Global Britain’ cadre, as it appears that finally the UK may deliver the Brexit its citizens demanded in that historic vote of June 23rd, 2016.

With the outbreak of leadership by PM Boris Johnson, a concomitant outbreak of government could pave the way to a brave new world of UK free trade. In that spirit, LSEG jumping in to snatch Refinitiv (at a hefty premium – Blackstone paid the equivalent of $20 billion just 10 months ago) is a clear pivot not just towards a fascinating vision of a big data world but also a repositioning of the LSEG London-Milan axis towards a significant position with a US-headquartered entity which derives revenue right across the world (Refinitiv has 80 offices worldwide, less than a third of which are in the EU27).

The deal is not yet done and it may yet prove a merger too far for a London Stock Exchange Group where management has recently proven eager to make deals, but perhaps not so skilled at genuinely integrating their purchases thereafter. With barely 5,000 staff, LSEG will be dwarfed by Refinitiv’s 18,500 employees.

Most worryingly, the old Reuters entity has never been overly imbued with a sense of adequate management according to many who either worked there, or have tried dealing with an often quaint concept of customer service. Big data delivered by a bloated entity may worry investors that the LSE’s new generation of deal-driven management are not the right people to finally get the Thomson Reuters behemoth ‘match fit’ for the digital age.

Reuters has spent the past 30 years in an essentially unstinting arc of relative decline. Once the dominant terminal vendor, relative upstart (founded 1981) Bloomberg has been the market leader for years (apart from a brief period when Thomson and Reuters combined their vendor businesses, only to fall behind once again soon after).

There are many interesting opportunities in market structure, but the big groups often appear less patient to buy and build, and so are driven to ever larger mergers, often spurred by investors seemingly impatient for rapid returns. Big data is clearly a massive opportunity in a financial market voraciously analysing every last megabyte in the quest for even an infinitesimal investment edge.

Meanwhile LSE is sending a clear message to Brussels that it perceives future growth more in the world beyond EU27 with a deal which expresses confidence in the future of London, the world’s largest international financial centre.

For those investing on the LSE itself, little will probably change – but around the edges there remains a world of opportunity for exchanges. Building a digital data powerhouse has huge potential for LSE, as it follows a path already successfully undertaken by the best managed exchange group, InterContinental, whose inspired entrepreneurial CEO Jeff Sprecher also has a significant UK footprint.

In 2015 Sprecher bought InterActive Data Corporation for $5.2bn  as a cornerstone of his big data strategy – a deal which on a larger scale LSE now seeks to mimic.

Whatever data benchmark you prefer there is one clear conclusion – LSE Refinitiv won’t be the last big data deal involving the parish of exchanges.

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Patrick L Young is a former exchange CEO who wrote the original best selling book about fintech “Capital Market Revolution!