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22 October 2006

FT: Lessons from the Big Bang for big bidders today

The mating game was – and will be – costly

The Big Bang on the London Stock Exchange, whose anniversary falls this week, was a historic liberalising measure that profoundly changed the City of London. Today, we are on the brink of another revolution in the securities markets spurred by technological change and the deregulatory Market in Financial Instruments Directive (MiFID). Are there any lessons from the earlier reform that are relevant today?

The most striking one is that the winners in the Big Bang were not the players that tried before the change to assemble fully integrated investment banks via acquisitions. Goldman Sachs and Morgan Stanley, who bought people, not banks, did far better than those like Barclays or SG Warburg, who threw together seemingly impressive combinations of broking, market making and corporate finance. Those who did succeed with acquisitions waited until much of the dust had settled. Merrill Lynch was a case in point with its purchase of Smith New Court, as was UBS, which now owns the residue of Warburg.

That underlines the temerity of those stock exchanges that are currently playing a mating game before the Mifid deadline of November 2007 and before we have clarity on how competition policy will affect clearing and settlement in Europe.

As in 1986, nobody can be sure how the dice will fall or how dramatic the Mifid revolution will be. It is even possible that liberalisation will not be revolutionary, especially if, as mooted here on October 9, stock exchanges cut their fees to deter the banks from poaching on their territory.

Yet, as Graham Bishop argues, in by far the best report I have seen on Mifid, prepared for LogicaCMG, there could be a bigger bang than generally expected.*

The current assumption in the London market, he says, is that only 5 to 10 investment banks will become EU-wide “systematic internalisers” – securities firms who have such a large flow of client orders that they can profitably match orders in-house instead of taking them to an exchange. They will challenge the exchanges by competing across the breadth of liquid EU shares, whereas the exchanges mainly compete vertically in their national space.

Mr Bishop argues that, if technology is sufficiently cost-effective and banks can have access to settlement on the same terms as the exchanges, it will make sense for any serious provider of order flow in a national market to attempt to capture internally the profit of that trading. Technology costs are in fact falling and, he suggests, banks may entertain exaggerated fears of those costs, much as they did before the introduction of the euro. He thinks the number of systematic internalisers could turn out to be 50 or more.

If he is right, then would-be purchasers of European exchanges at today’s heady valuations could find that the goodwill arising on acquisition is subject to early and large impairment charges. Mergers and acquisitions are hard enough to pull off when conditions are stable.

When the future is a complete fog, the chances of success may be remote.

* MiFID – an opportunity to profit,
By John Plender

© Financial Times

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