alsek press

Prognostication of a market-based governance system, one where global development is driven by free-market forces, is supported with the accelerating globalization of the financial industries, particularly the stock exchanges. Emerging as a leader toward a unified global system is the projection of what could soon become a Global Stock Exchange made up of either one dominant exchange or two primary exchanges, restructuring the global stock, commodities, and currency markets. 

The brisk merger activity among stock exchanges is forming interdependent, global financial markets and creating shifts in the forces within financial systems, most importantly the power structures. These long-term structural changes bring new characteristics and powerful implications that impact not only the global economies, but also corporate strategies and individual investors’ decisions, requiring a different way to look at the new landscape emerging in the trading environment.

The current phase of rapid consolidation of exchanges was propelled by the New York Stock Exchange when it became a public corporation in 2007. At that time, the purpose of the exchange shifted away from providing an organization supporting members of the exchange to maximizing business profitability by horizontally expanding with immediately acquiring Euronext, the European exchange. A merger and deal mania among exchanges and related infrastructure companies started a competition to capture international territory.

With the spread of the adoption of capitalism and free-market economic systems, countries with nationalized exchanges will be unable to compete against the behemoths created by the mergers and acquisitions (M&A) that are forming a globally interconnected trading system of powerful networked partners. The vertical and horizontal depth of the M&A activity spreading into other segments of the investment industry advances the efficient infrastructure, which opens a myriad of opportunities for new financial product innovations. However, it also creates structural changes that will alter the future of equities’ market behavior. These opportunities attract new entities, which in turn will create new challenges as different major factors surface.

Global Reach: The Changing Landscape

M&A activity is forming a global financial landscape layered with intertwined, networked exchanges and affiliated stakeholders servicing the different subsets of companies from large multinationals to small firms, all seeking exposure to international investors. This phase of consolidation, led by the two largest exchanges—the NYSE/Euronext and NASDAQ—is shaping into a few predominant transregional systems. The rate of expansion follows the rate of change made in emerging regions’ regulatory policies as they allow foreign ownership of national exchanges, open free markets, and form strategic alliances to share trading platforms or other transaction-processing systems. 

Distinct financial centers are arising within the regionally centered, interdependent systems, as the competitive race to capture markets in equities and other financial products repositions national players. Since many of the major markets (e.g., the BRICs—Brazil, Russia, India and China) still restrict foreign ownership, the final alignments culminating into power centers remain unforeseen.

 [INSERT MAP]

In 2004, NASDAQ started competing for the listing business by offering dual NYSE-NASDAQ listings for companies. New accounting standards that allowed companies to cross-list on foreign exchanges significantly expanded their access to foreign investors and larger markets. Now, U.S. investors can access more than 420 non-U.S. companies listed on the NYSE and approximately 335 on the NASDAQ exchanges and through American Depository Receipts (ADRs). Companies registering initial public offerings that want the benefits offered by the NYSE, but do not want to pay the costs incurred when registering as a U.S. offering, can go through Euronext, a branch of the NYSE. 

In the future, as the exchanges continue to merge and share infrastructure, the trading landscape will likely morph into one interconnected exchange, where trades will be accessible to any investor on a centralized trading platform. The listing exchange and regulations will be transparent to the trader. Until then, the primary driver of the industry’s consolidation will be competition for the potential surge of liquidity found in new emerging markets.

Both regulatory changes and advancements in electronic trading systems enabled exchanges to go global. NASDAQ, which started as an electronic exchange, always had a strategy to build an international trading service based on an online trading system. Since the 1990s, NASDAQ has built a foreign presence through various alliances, starting with a joint Internet information service with Hong Kong Stock Exchange and its launching of the NASDAQ Canada in 1999. 

On the European front, the Paris, Brussels, and Amsterdam exchanges formed the Euronext in 2000, which also acquired the Portuguese Lisbon exchange. In 2007, as soon as the NYSE became a public corporation, i proposed a merger with Euronext, which was finalized in 2008 to form the largest stock exchange, valued at more than $20 trillion.

Table 1:  Top 10 Stock Exchanges

 Stock Exchange   Market Value              Total Share  Turnover

     ($US trillions)     ($US trillions)

NYSE Euronext     $20.7   $28.7

Tokyo         $4.63   $5.45

NASDAQ   $4.39   $12.4

London       $4.21   $9.14

Shanghai    $3.02   $3.56

Hong Kong $2.97   $1.70

Toronto       $2.29   $1.36

Frankfurt    $2.12   $3.64

Madrid        $1.83   $2.49

Bombay      $1.61   $0.263

Source: Wikipedia. 

The NYSE takeover of Euronext triggered a rush for stake claiming. However, the bidding wars started when the NASDAQ, a 15 percent stakeowner in the London Stock Exchange, made a bid to acquire the remaining LSE shares in 2006. The offer was rejected. However, the aggressive move to take over the third most active exchange pulled Borse Dubai, a United Arab Emirates exchange, into negotiations. 

The ongoing fight to acquire the LSE ended with a shuffle of convoluted ownership structure. Borse Dubai settled with a 28 percent stake of the LSE purchased from NASDAQ’s shares. NASDAQ will become the principal commercial partner of Dubai International Financial Exchange in exchange for the Borse Dubai taking 19.99 percent stake in the NASDAQ. And Borse Dubai will take on the NASDAQ branding name.

While the LSE fights to maintain its independence and ward off takeovers, the NYSE and NASDAQ continue to build their global networks. In 2008, NASDAQ and the OMX (agglomeration of Stockholm, Helsinki, Copenhagen, Latvia, Lithuania, and Estonia exchanges) will merge into the NASDAQ/OMX, pending approval by Sweden and other Nordic and Baltic jurisdictions. The agglomeration of the various NASDAQ mergers and alliances will cultivate the first exchange that will span the United States, Europe, and the Middle East regions.

The emergent organizations do not clearly define territories or differentiating regulations. Dubai has plans to become a major financial center servicing the Asian region between East Asia and Europe. Singapore, already an established financial center for the Asian-Pacific region, is a prime target for M&A activity as that region develops. In 2007, Tokyo purchased 5 percent of Singapore Exchange, SGX. Rumors say TSE plans to take a major stake or acquire SGX. That could expand the products and technology the Tokyo Stock Exchange already shares with the LSE. However, targeting the Asian region is already part of the NYSE Euronext and NASDAQ expansion strategies.

Aggressive-deal making activity is not limited to any city or country, but surfaces in all areas that enable foreign participation. NASDAQ long ago established an office in India, and NYSE Euronext already purchased the maximum allowed foreign ownership of 5 percent in India’s Mumbai exchange, the National Stock Exchange. The NYSE also made headway into China with the first registered representative foreign exchange office.  However, the advantage of any leading exchange may change as restrictions on foreign ownership are lifted in the emerging regions.

As globalization of the industry opens opportunities, the pressures to perform as a publicly traded company will fuel further consolidation necessary to achieve efficiencies of the integrated technologies and to exploit the massive global market. Small, regional, and single-platform exchanges will be unable to compete.

New Forces in the Global Exchange System’s Structure

As a revolutionary exchange structure emanates, new powerful forces will impact directions of the global economy and wield enough power to influence regulatory policies governing regional economics and foreign trade. Electronic trading systems, coupled with a new massive market composed of different players, could create significant shifts in the distribution of global capital formation. Also, both infuse different behaviors into trading systems. 

Information technology has leveled the playing field by providing access to information and electronic trading to individual retail traders with the same detail as professional traders and institutions. However, the expanded base of traders also introduces new investment strategies, trading styles, and intentions, often with conflicting goals. Many new traders and investors making the market are from regions that only recently adopted open markets and capitalist economic structures, where individuals may not be protected from market fluctuations. The dynamics of matured trader groups intermingled with novice entrants, whose understanding of market behavior is based only on current market conditions, could incite volatility both in the trading arena and in the economies of specific regions—if shifts of fast money constitute instability. Conversely, a more risk-averse group of global players could add stability or induce new agents that would balance short-term speculative progression.

Spread of Risk and Governance

The expansion of the market adds liquidity, which fuels more economic opportunities. The diversity of players that comes with an international market also changes along with the shift in large holdings. Institutions, such as insurance companies, pension funds, and corporations, utilize different avenues to invest large pools of capital with minimal impact to any particular stock or market. However, foreign institutions are now composed of large sovereign funds that often trade on the open markets and impact certain sectors and individual stocks. Concerns regarding their intentions, or at least their ability to have control over stocks, industrial sectors, and regional economies, are heightened by the lack of regulation, accounting standards, and transparency of the foreign entities. 

Escalating numbers of pension funds spread across the world, along with economic growth in the emerging regions, should mitigate any intent to manipulate a targeted stock or economy by a sovereign entity. As the dispersion of foreign investments widens, the sovereign fund could expose its own country’s downturn risks through the fund’s other investments. Any sovereign funds concentrating financial activity to a specific target will likely trigger intervention before any significant event occurred.

The integrated connectivity of the pan-global exchanges, as mapped in the NYSE and NASDAQ expansion, provides the means to spread risk and leverage accumulated wealth, which is likely to be of more value to any fund in a global economy than beget a countervailing force. Intentionally threatening a global imbalance would provoke protectionist policies that could reduce capital flow to that country. Hence, impacting capital formation would likely be avoided. However, capital infusion could be used to influence countries’ and corporations’ decisions that indirectly impact the trading environment.

The trading environment is a large, interdependent system, so the emerging structure will likely develop into a self-correcting, balanced system that is less overpowered by waves of momentum and speculative trading. However, the probability of forces threatening the system’s performance rises if foreign markets overadjust with regulatory policies that impact the integrated global market as these countries learn market-based economics.

The formation of regional financial centers, such as New York, London, Dubai, and Singapore, plays a key role in global stability. This is a step forward in the globalization transition, which leads to international regulation and has the potential to undermine the powers of nation-states. 

Eventually, the global exchanges will have to agree to a set of international standards. Without those, the practices of all players may not be in the best interests of any particular country. An example is speculative commodity prices driving up inflation, which could hurt economies that cannot absorb the costs. Another example is the 2007 subprime mortgage crisis, which started in the United States and rippled throughout the foreign exchanges due to foreign participation in the derivatives, yet alleviated some of the risk to the United States. Risk will increase as countries deregulate to participate in the global market. Competing financial instruments will propagate new investment opportunities, which will continue until creative financing is exhausted or the ramifications from regional regulatory regimes pose predatory or protectionist repudiation. The most significant benefit of a global market is that risk is spread across the world.

The decoupling of investment banking from commercial banking regulations has opened the doors for developers of creative securitization that has embedded unregulated financial instruments in the complex integrated systems; such moves expose innocent recipients to unknown high levels of risk and insecurity. Without a set of international accounting standards, the exploitation of unregulated securities by passing them through regulated funds will become harder to track as the portfolio of investment products inflates choices.

The geographic diffusion of shocks no longer depends on the epicenter of the shock or the periphery. The spatial dislocations are now more dependent on the linkage between the participants in the arbitrage. Episodes that cause economic crisis to a particular country will receive pressure from agents in the trading system. The correcting mechanism will come from the periphery (countries) that will impart controls on the market, which is more prone to organization based on human behavior. The free-for-all speculative trading that some fear will lead to a gambling market should evolve into a global institution with universal ideologies. Decision making will shift from the financial institutions, broker/dealers, and traders as the center of gravity to a universal world order. Organization will not be based on ideologies, but on risk management of an integrated economy.

Globalization has shifted traders’ awareness from regional centers to the core of financial centers. Economic concerns that impact overall exchange performance arise from adverse shocks to asset sectors. Political or economic instability at the periphery usually remains insignificant, discounted with little impact on markets. This global mind-set vs. a regional mind-set will prevail in a pan-regional marketplace.

Capital Formations and Shifts in Distribution

A global stock exchange platform makes the opportunity for asset accumulation available to more people. Inequalities in capital formation can accrue in open markets if governments are left out of the distribution architecture. As countries adopt market-driven governance, more people will be pushed toward participating in pension funds and other types of private investing in a system that used to be exclusive to the wealthy and countries with stable exchanges. The self-organizing system will increasingly expose retail traders to a complex array of investment choices and schemes. “Smart money” and institutional traders moving into assets that require an understanding of sophisticated asset management to yield the higher rates of return will leave individual investors to lower-return assets, thus perpetuating the increasing gap between wealthy capitalists and investors attempting to generate pensions. 

Investments maximizing returns by chasing emerging regions and innovations can infuse significant amounts of capital into a region or sector without having a long-term commitment. The risk of oscillating and massive withdrawals exposes regional development to the vulnerabilities of market sentiments. Any increase in volatility or instability created by the diversified pool of investors could cause governments to change policies regulating foreign ownership and investments.

     If systemic problems in the global exchange become unpredictably chaotic, investors and institutions will decouple from the public exchange and migrate to alternative trading platforms, such as the emerging private exchanges, to invest among a more-efficient market in a lower-risk environment. These exchanges could draw the liquidity, often called “dark liquidity,” from the private equity firms and major markets as companies look for some regulation, plus the necessary liquidity to facilitate large transactions. 

These alternative trading platforms could disrupt the financial landscape and the structured network of exchanges by aligning with partners from other segments of the financial industry, such as banks, service, and technology providers. Depending on the formation and allocated resources and alignments, each exchange offers differentiating services suitable to the goals of large block traders. 

In 2007, NASDAQ announced its PORTAL Market, a closed trading system available to brokers and institutions trading 144A securities (unregulated securities restricted to qualified institutional buyers worth more than $100 million). The trading platform increases the liquidity by enabling foreign investors and other qualified parties to conveniently participate in private sales of 144A securities through an efficient execution network.

Private exchanges operate not only with minimal regulation, but also with no transparency. Qualified investors that can absorb risk are invited to trade large blocks in Project SmartPool, an electronic block trading market accessible to European sell-side firms, a partnership between the NYSE Euronext and investment bankers NP Paribas and HSBC. Parties will be able to trade without disclosing their identity or the bid/ask prices or size of trade. Minimal information will be required pre-trade, and information will only be posted after settlement.

Alternative exchanges are outcomes of regulations, such as MiFID in Europe and Reg NMS in the United States, which take the investing environment from a highly controlled regulatory structure to a free-market system. The flood of new products and platforms for trading and investing that comes from deregulating the industry will continue to change the landscape as interacting participants produce a collective structure. These “dark liquidity” trading platforms are estimated to already process more than 5 percent of the trading volume in the United States.

Changes in Investment Strategies

The evolving exchanges present dynamic and fluid options to the individual trader, brokers, and corporations. The changes in the trading environment’s system structure will likely require adjustments in strategies to include more risk assessment and more sophisticated methods to identify opportunities to generate capital gains. The complexity of the system will only grow as integrated pan-global exchanges open foreign markets to more investors.

Analysis of any market will require an international mind-set, a global view, and a whole-system understanding. Investors—corporate, institutional, and individual—will have to be able to assess opportunities throughout the world, not necessarily by regions, but by individual stocks. With an interconnected system, a company of any size need not depend on its economic success being linked to a country or region, but rather on its competitive position in the world market.

The complexity of understanding the expansive landscape saturated with a myriad of financial products and equities could have a residual effect that slows down the capital distributions while the system finds stability. Likewise, the risk and volatility from an open market system could push private investors to seek stability in funds or drive out players from the market, which will reduce liquidity and cause further downturn.

Corporations may opt to list with exchanges that are less regulated to avoid stringent reporting rules such as Sarbanes-Oxley requirements. Likewise, other companies may seek a regulated environment for stability. In a global financial system, companies have the option to choose the best match for their strategies, whether it is a foreign listing or a cross-listing. This makes a market of conflicting goals.

A corporation that wants the liquidity and ability to handle large IPOs, which would typically seek to be listed on the New York Stock Exchange, could list on a European exchange if the terms are more beneficial. The interdependent exchanges provide the option to raise capital and receive the securitization in multiple locations without dislocating the company’s central operations.

The threat from a listed company to move to another country will limit the ability of the SEC and other regulators to impose their will. These threats would be mitigated if investors prefer to keep their trading within a regulated framework for increased protection.

Overall, the structural changes in the globalization of exchange systems bring advantages such as an expanded market and opportunities for corporations. However, challenges could become disadvantageous for individual traders. 

A rise of private exchanges could leave the NYSE and NASDAQ to be the after market for individuals, which would result in these exchanges becoming a gambling system functioning on behavior and computerized algorithms than investments. Those characteristics could become more pronounced than the skeptics already perceive. Individual traders could be shut out of the lucrative IPO market if initial offerings migrate toward private exchanges or other instruments where there is less volatility. This could lead to only high-risk IPOs that are more likely to fail or be insignificant to debut on one of the major exchanges (NYSE, NASDAQ, LSE).

The decoupling of the large block institutional traders from the public exchanges would grossly affect stock market performance. Left to individual players, the market would become more of a behavior and sentiment indicator than an economic barometer. Fads, bubbles, and momentum could dominate strategies. Timing the market would become a prevalent tactic rather than short- and long-term investing. This would leave less-active traders disadvantaged in a constantly fluctuating market.

Protection will be needed for individual investors who have to rely on investments for retirement, particularly if Social Security becomes privatized or there are other disruptions in pension assets. However, the massive aging population could force alternative safe havens to be offered. Demand is expected only to increase with the growing aging population around the world. But it is the role of the industry to provide options for security. The conflict will be between a global exchange, which has a purpose to maximize opportunities fueled by liquidity, or secure programs for asset protection and subscribed payout.

Future Outlook

Globalization of exchanges will continue to evolve and revolutionize the financial industry as new economic theories are explored. Products for creative securitization will be tested. And the role of global exchanges will be scrutinized as they struggle to improve their competitive position vs. providing options that are in the best interest of investors.

The solidity of the entire global financial system will likely require somewhat of a regulated architecture. Else, national economies run a risk from potential spillover effects resulting from events in other regions. Being on the periphery of an interconnected system does not provide any safeguards from the core’s behavior.

In an open market, government policies will be less influential than traders’ behavior. Exchanges will become more representative of a gambling environment than an investment platform. And even though the stock market has been long compared to a casino, that strategy will dominate until an event disrupts the fundamental structure created by a shift in electronic trading system’s methods. 

As with globalization of any industry, continuing deregulation in the financial sector will nurture more creative products, more competition, and more consolidation until a chaotic environment stresses the current trajectory and causes a sharp reversal. In this industry, there would be no reversal of a global exchange, but the force of an international regulatory body would prevail. Fragmentation of the major exchanges will result when the rise of private exchanges draws liquidity from the major markets to the point of reducing performance and functionality. Other alternative collective structures could emerge from restructuring alliances in multiple sectors, such as technology companies.

As with all systems, the trading exchanges will continue on an evolutionary path. And while in the era of globalization, they will continue to go through stages and phases of consolidation and fragmentation, just as other industries do. However, since the stakes can be high when dealing with huge sources of capital and economic control of companies, industries, and countries, wild cards are a possibility, although unlikely due to sophisticated monitoring. The advantage of an interdependent exchange is that it is based on an electronic platform that tracks all transactions. 

A wild card that would disrupt the trading revolution might be, for example, a sovereign fund with enough wealth to overpower or threaten a major economy by successfully manipulating a market, which would lead to financial wars. However, evolution of a global economy makes most countries participating in it interdependent, with a high probability that spillovers of any cataclysmic event would carry significant economic damage to the perpetrator.

A more likely scenario is the rapid shift between dominant regional financial centers that would lead to a significant global imbalance of major economies and threaten a global economic collapse. This is in line more with the emergence stage of a self-organizing structure. At that point, controls would be put in place to stop economic destruction and reverse course. Success of these controls depends on the governing bodies to implement appropriate measures and acknowledgement by the global community of the inferences.

The trajectory building by the consolidation of exchanges, overall, produces benefits that far outweigh risks. Cycles and instability can slow down the evolutionary process, but will be corrected. Alternative exchanges and complexity may drive traders out as players, but capital will remain in the system by means of one of the integrated options. Complexity could also create opportunities for those who have different skill sets and strategies to work within the new systems.

References

Berger, Suzanne. 2003. The First Globalization: Lessons from the French. MIT, http://web.mit.edu/polisci/research/berger/lessons-latest_English_version.pdf.

Forbes, Kristin. 2007. “Global Imbalances: A Source of Strength or Weakness?” Federal Reserve Policy in the Face of Crises. Cato Institute (April 11).

Forrester, Jay. 2003. “Economic Theory for the New Millennium,” Plenary Address at the International System Dynamics Conference, New York (July 21).

Kaminski, Graciela L., and Carmen Reinhart. 2002. “The Center and the Periphery: The Globalization of Financial Turmoil.” International Monetary Fund (November).

Knowledge@Wharton. 2002. “Global Securities Markets Present Tough Challenges for Investors and Regulators.” http://knowledge.wharton.upenn.edu (January 16).

Knowledge@Wharton. 2006. “LSE, NYSE, OMX, Nasdaq, Euronext ... Why Stock Exchanges Are Scrambling to Consolidate,” http://knowledge.wharton.upenn.edu (March 22).

Knowledge@Wharton. 2000. “Stock Exchanges in the Market for Partners,” http://knowledge.wharton.upenn.edu (June 7).

Mosley, Layna, and David Andres Singer. 2006. “Taking Stock Seriously: Equity Market Performance, Government Policy, and Financial Globalization.”  MIT, http://web.mit.edu/dasinger/www/MosleySingerNov14.pdf (May).

Moyer, Liz. 2007. “Barely Private Exchanges,” Forbes (August14).

NASDAQ corporate, http://www.nasdaq.com.

NYSE Euronext corporate, http://www.nyse.com.

Shaw, Richard. 2007. “A Unified, Global Stock Exchange May Be Approaching,” http://seekingalpha.com (November 21).

Thurow, Lester. 1997. The Future of Capitalism. New York: Penguin Press.

Veon, Joan. 2006. “The New York Stock Exchange Goes Global: The Cherry on Top of World Government,” http://rense.com (March 8).