HKEx’s (0388.HK) audacious $32 billion bid for London Stock Exchange Group (LSE.L) raised quite a few eyebrows on 9/11. Three immediate questions were raised by the bid. First, does the bid make sense for shareholders on a commercial basis? Second, what are the strategic considerations for Hong Kong and global financial markets? Third, what are the regulatory and geopolitical hurdles?
My own policy is never to make any predictions on the prices or viability of any commercial deal but to let facts speak for themselves. At present prices, HKEx is the third largest listed exchange in the world with a market cap of $40 billion, larger than the LSE ($31 billion) but smaller than the CME Group ($77 billion) and the Intercontinental Exchange Inc (ICE, $53 billion). The fact that the LSE share price rose slightly after the bid announcement but remained lower than the bid price by HKEx suggested that the existing LSE shareholders are not particularly enthusiastic. On the other hand, HKEx price fell slightly as the merged institution will have a return on equity lower than the current level of around 24% (15% for LSE).
As part of the team that pushed for demutualization of HKEx in 1999/2000 when I was at the Securities and Futures Commission of Hong Kong, it may be useful to recall the logic for its consolidation and eventual listing. The objective then was to merge the Stock Exchange, Futures Exchange and the Hong Kong Securities Clearing Company (HKSCC) into a single holding company that would be listed and lead the path of improving the financial technology infrastructure for capital markets in Hong Kong. In 2012, HKEx acquired the London Metal Exchange (LME) for £1.4 billion to strengthen its commodity trading. By attracting Mainland company listings, the HKEx has been ranked number 1 in global IPO funds raised in 6 out of the last 10 years.
Since 2000, the financial markets landscape has been profoundly transformed by technology and structural changes. Whereas traditional exchanges would dominate most of the equity trading business, today alternative trading systems (ATS) account for just under 40% of all equity business. Brokers today can either fulfill orders through their own books, do an over-the-counter (OTC) deal with market makers/liquidity providers, or engage in dark pools (off-exchange ATS) that just match deals, cheaper and faster than through traditional exchanges or clearing systems. In the US alone, there are 13 exchanges competing with 33 equity ATS and various OTC platforms.
In short, competition in the exchange business is fierce.
After the 2008 global financial crisis, with financial transactions peaking in most advanced markets, with the exception of the US, the business also changed. The US has maintained its superior lead over all other equity markets with a total market share of roughly 41% of total global market cap since 2005. The relative shares of UK, Japan and Europe respectively fell from 7.5%, 18.4% and 17.3% to 4.9%, 7.1% and 10.8% of total world market cap, reflecting the problems in their economies.
On the other hand, the Chinese market cap’s global market share rose dramatically from 1% to 8.5%, whereas Hong Kong’s share doubled from 2.6% to 5.1%. This was mostly due to the equity fund raising (IPO) of Chinese enterprises. In 2016, Chinese IPOs in Mainland and Hong Kong accounted for just under one-third of global equity issuance. Going forward, this trend will to continue as Chinese enterprises deleverage and float some of their most innovative companies domestically.
Given the fact that global investment banking and securities market revenues have remained stagnant (in spite of the buoyant US stock market), the large exchanges are looking for strategic ways out of the revenue/scale/technology quandary.
The LSE found its strategic solution through the combination of its exchange trading business with the financial data analytics business of Refinitiv, which was carved out from the old Thomson/Reuters data business. In other words, you move out of the financial trading into the data analytics business where Big Data and Artificial Intelligence promise new sources of revenue. In July, LSE made a £27 billion bid for Refinitiv, which is owned by a consortium of shareholders, including Blackstone, Canada Pension Plan Investment Board and GIC Singapore. The combined business will be headquartered in London.
Both bids will be subject to regulatory and geopolitical considerations. The LSE/Refinitiv deal will have to satisfy both the competition and financial regulatory authorities in the US, Europe and the United Kingdom. Given that Refinitiv has about 23% of the financial data market, as against the market leader Bloomberg with 33% market share, the competition regulators would be concerned about the data issue, especially if these are owned by what they would consider to be a Chinese (although Hong Kong) company. The HKEx bid, however, has excluded the Refinitiv part, presumably because it recognized that regulatory issues over data would be complicated.
The current state of politics in both Britain and Hong Kong further complicate matters. The LSE has had talks on and off with Deutsche Boerse and after Brexit, it may still make sense to have merger talks in order to access the Euro stock markets. The US authorities may not be that concerned about LSE merging with European stock exchanges, but would certainly have a strong view on whether LSE should be owned or controlled by Hong Kong or Mainland Chinese shareholders. Indeed, the fact that the largest shareholder of HKex remains the Hong Kong government, which nominates by law six board directors, may be an area of regulatory contention.
My bottom line is that the days of global exchanges are numbered by both the technology and the geopolitical concerns. Ultimately, it is all about whether these exchanges can transform their business to extract efficiency and value for their customers, and not just shareholders. But whether that will satisfy the politicians who still see markets from the sovereign perspective, that is another story.