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Why Stock Exchanges Are Such Hot Properties

Companies / Sector Analysis Mar 25, 2011 - 12:37 PM GMT

By: Money_Morning

Companies

Best Financial Markets Analysis ArticleMartin Hutchinson writes: Stock exchange mergers are all the rage these days.

The NYSE Euronext Group (NYSE: NYX) and Deutsche Boerse AG are attempting to merge and the London Stock Exchange Group PLC and TMX Group Inc. are also getting together.


The deals are the latest in a consolidation cycle among exchange operators that has accelerated over the past decade. In 2010, Singapore Exchange Ltd. (PINK: SPXCY) agreed to an $8.3 billion takeover of Australia's ASX Ltd (PINK: ASXF) to create Asia's fourth-largest stock exchange. And IntercontinentalExchange Inc. (NYSE: ICE) purchased the Britain-based Climate Exchange PLC (PINK: CXCHY) that same year for $597 million.

So I would not be at all surprised to see other bourses follow up with stock exchange mergers of their own.

CME Group Inc. (Nasdaq: CME) and Nasdaq OMX Group Inc. (Nasdaq: NDAQ) still haven't ruled out a potential counteroffer for NYSE. And some analysts speculate that the Nasdaq could be the first U.S. stock exchange to tie-up with an Asian partner.

Indeed, for the exchanges themselves, there appear unlimited possibilities of expansion, mostly in the derivatives market.

But the sad truth is that the only thing individual investors are likely to get out of all of this activity is a sneaky increase in fees.

The Business of Being a Bourse
The main driver behind exchange mergers is the dream of global dominance. The NYSE controls Euronext, which itself is an agglomeration of several Paris-based European stock exchanges (including the old Paris Stock Exchange). So a Deutsche Boerse-NYSE tie-up would give the merged exchange dominance in all major global markets except Asia. (Admittedly that exception is a very important one, since the volume of initial public offerings (IPOs) on Chinese stock exchanges in 2010 exceeded that in the United States.)

However, since regulators have forced derivatives trading increasingly onto exchanges, and since the volume of derivatives outstanding is a large multiple of world gross domestic product (GDP), the revenues available from achieving dominance in the global derivatives markets are very substantial - even if the fees charged are only a minuscule portion of each individual trade.

The other new business that has made global stock exchanges attractive assets is that of computerized "high-frequency trading." Here, computers located within feet of the central exchange use complex mathematical algorithms and their early knowledge of the order flow to make infinitesimal profits, but millions of times a day.

As I have written previously, this is an entirely parasitic business, since it involves trading on insider information, knowing the flow of orders before the general market, and taking advantage of this knowledge. As with many Wall Street scams, the lobbyists were able to ensure that no significant control of this business made it into last year's Dodd-Frank Wall Street Reform and Consumer Protection Act.

As high-frequency trading makes up an ever-larger proportion of the order flow, the market's price-discovery mechanism becomes ever more corrupted - and exchanges become ever richer. Thus market share in this business is highly attractive, leading to mergers.

Implications for Investors
Needless to say, the merged exchanges have almost no interest in business from you and me. When I sold $5,000 worth of shares recently, the exchange charged me 7 cents. Multiply that by the 40-50 trades I do a year, and you're still only talking about $3.00 or so. Multiply that figure by all the individual investors in the United States (except for a few trading-obsessed semi-professionals, most of whom have lost their shirts in the last few years) and you're still not talking about enough to pay a lot of bonuses or build a business strategy.

In other words, we are mere hangers-on, meaning we're of very little interest to the managers of the merging exchanges.

You can see this from the lack of benefits previous mergers have brought us. You would have thought that the merger of the NYSE and Euronext in 2007 would have enabled us to trade French stocks as easily as U.S. stocks, but far from it. Except for those few French companies that have gone to the expense of creating and issuing American Depository Receipts (ADRs), and complying with the Sarbanes-Oxley regulations, it is just as difficult now to trade French shares as it has always been in the past.

Similarly, the Deutsche Boerse merger won't give us access to any extra German shares - a pity since Germany is currently the developed world's best growth market. A few brokers are now starting to offer investors the ability to trade on a limited number of foreign exchanges, but that's still by no means universal, and exchange mergers won't affect it much.

One major reason why we cannot trade easily on foreign exchanges is that the Securities and Exchange Commission (SEC) has not cleared most foreign shares to be sold to U.S. residents. To some extent I can see the SEC's point. For some reason - I must have accidentally been polite to someone - I got on a list whereby every dodgy broker in the United States feels entitled to call me up and try to sell me rubbish. Obviously, they wouldn't be doing this if there weren't people who have succumbed to their badgering and bought the rubbish they were selling. So allowing such salesmen to operate globally would merely increase the number of scams sold to U.S. investors.

However, if the SEC wants to protect us it would do better to go after the crooked brokers. Those of us who make our own investment decisions, and probably use a discount broker to execute trades simply to avoid the full service broker's bad advice, should be entitled to venture beyond these shores.

These days, information about global stocks is readily available, over the Internet or better still through Money Morning and Money Map Press, which unlike the dodgy brokers, are trying to build our wealth, not just our trading volume. We the intelligent and well-informed should not be held back by the failings of the gullible.

The Bottom Line: Stock exchange mergers will do nothing to help us invest internationally. The biggest likely change for us is that, if one of the behemoths establishes a global monopoly or near monopoly, trading fees will go up. You can count on it!

[Editor's Note: There's a segment of the stock market whose investment returns are five times that of the typical stock.

But here's the problem: Only 1% of investors know about it.

Fortunately, Money Morning Contributing Editor Martin Hutchinson is among that 1%. The 37 years he spent as an international merchant banker gave him that knowledge, and that insight.

Now you can access that insight.

With Hutchinson's The Merchant Banker Alert advisory service, you can crack this "rich-man's market," discover the identities of those stocks - and reap those massive gains yourself.

Click here for a report that shows you how to get started.]

Source : http://moneymorning.com/2011/03/24/...

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