IN THE CITY, IT'S MARKETS THAT COUNT

Brian Williamson says

that there's more to life (and Liffe) than the Stock Exchange

ION Snow, opening Channel 4 News at seven o'clock on 5 April this year after the London Stock Exchange systems had failed for most of the day, announced that the City of London had ground to a halt.

This was indeed news to the 210,000 people who had been to work there that day. It had been a rather lively day for them, grinding away at the mill, and fewer than usual would have made it home in time to catch his apocalyptic words.

Those in the foreign-exchange markets had once again turned over $500 billion, more than the combined efforts of their counterparts in New York and Tokyo. London's eurobond dealers had pushed around more international bonds than any- where else in the world. Short-term shov- ellers, sensing that interest rates might not have peaked, had their busiest day for a month, and dressed-down derivative traders in the 250 dealing rooms connected to Liffe, the futures exchange, where they turn over the gross national product of Euroland every month, tapped in another 330 billion euros' worth of business.

`Don't forget the shipping market,' said Hugh McEvoy, then chairman of the Baltic Exchange, to some City types at a dressed- up breakfast early the next morning at Mansion House. Brokers had broked; ships had sailed; flags had flown; and Britannia, impassive in the portico of the Bank of England's facade, had gazed down on yet another fine day watching the toilers feed- ing the cogs of the world's most sophisticat- ed piece of financial machinery. She had seen nothing unusual — but then she would also have missed the news at seven.

So what did it really matter if one of the City's many equity exchanges had dropped about a billion pounds worth of business? It was hardly a drop of oil on the factory floor. So what?

The City's success lies in running mar- kets, not exchanges. Indeed, the most suc- cessful markets — those in foreign exchange, money and bonds — rub along without exchanges at all. In insurance, equities and derivatives, Lloyd's of Lon- don, the London Stock Exchange and. Liffe have all tripped up, yet the markets which they spawned thrive. Markets have got used to exchanges let- ting them down but, like members of a run-down golf club who put up with mis- ery in the club house for the opportunity of getting out on the course, they stick with them through thin and thin. Up until now. Technology has changed all that and the screen warriors in the City's dealing rooms and beyond tap out the message, `The Status Quo Will Not Do'. 'Liquidity, Accessibility and Transparency' is their war cry, not 'Who will we put up for the Council this year?' The patter of many fingers is telling the exchanges that if they don't adapt they will see business that they think is theirs by right or by 'fran- chise' (or, in more recent jargon 'our cap- tive pool of liquidity') disappear to other organisations whose names they have never heard of, or to exchanges which they never thought would be able to chal- lenge them.

Exchanges find themselves in a world where information is gathered faster than they anticipated or can emulate. Last year's bestseller on the future of capital markets forecast that fewer than five major worldwide stock exchanges would remain by 2010 and that perhaps two or three of these would be entirely electronic markets which have not yet been invented. This year you would be wise to be a seller down to 2005 if you can find a buyer, It used to be said that when an exchange had become successful enough to hold an annual dinner, it had done its job and the market would move on. Cruel commentators might conclude that Lloyd's of London's indulgent import of their magnificent Adam dining-room into their then new building designed by Richard Rogers, or Liffe's penchant in the Eighties and early Nineties for inviting Cabinet ministers to open new trading pits, or the London Stock Exchange's tenacity in per- sisting after Big Bang with its annual Christmas luncheon (hugely enjoyable though it was and is), were all ominous signs of ructions to come.

Some see the exchanges as the night- clubs of the City — good for a general sense of wellbeing, but not as important as they think they are. The bright ones spot a trend, exploit it and do well. The dullards who don't become passé, their doors close and their heydays are remembered by only a few romantics. The real stayers know that they have to combine hauteur with humility, because today's client has to be up early in the morning and has little time for romance.

The City and Suburban column in The Spectator once questioned whether Frank- furt would ever be a major financial centre with only one nightclub in town. Perhaps it was this that prompted Deutsche Borse's proposed merger of equals with the Lon- don Stock Exchange.

Everyone seems to think that the current debacle is the major issue in the Square Mile — a matter of national pride even. Yet markets are more cynical than that and certainly not as patriotic. Any survey of the major providers of global equity business, who are often based in London though owned elsewhere, would give a quite differ- ent perspective. Much of their business is transacted off-exchange, and for many their own business alone is bigger than many stock exchanges. To the extent that they do use exchanges they are looking for efficiencies in the less glamorous areas of clearing and settlement. They are much less concerned than might be thought about the future of national exchanges. Proof of that is that they are aggressive investors in the many alternative exchanges that have been set up to compete with the established ones.

Some of the major banks and securities houses played an intriguing role in the London and Frankfurt project — unfortu- nately named iX and swiftly dubbed Nein. Having lost patience with both exchanges, they rightly put pan-European settlement as their main priority, even threatening to bypass the clumsy efforts of the exchanges struggling to give them what they wanted. Yet three of them, Morgan Stanley, Gold- man Sachs and Merrill Lynch — known on Wall Street, and now here, as MGM — were deflected from this priority when they saw a chance to roll the Frankfurt exchange into (or over?) London's. Many wondered why they put so much faith in Werner Seifert, the chief executive of Deutsche Borse. He had acquired a rep- utation for charming his prey, but here was a fox who invited the hens one by one to his table for a 'feast between equals'. This engaging and determined Swiss had, with personal vision and the corporate backing of the major German institutions, built up a powerhouse in Frankfurt, but the record of co-operation with other exchanges was far from encouraging.

The muffled cheer that ran round the City when the iX deal collapsed was much less to do with jingoism or anti-German feeling (the City is not so stupid as to ignore the important presence of the Ger- man banks and institutions, and values their power as much as it welcomed the arrival of the Americans in the Seventies and the Japanese in the Eighties) as with a suspicion that the two exchanges were try- ing to tell markets what they should do. The markets are the masters now and the exchanges their servants.

The iX document had a dated and defensive tone that grated with the equity markets, which live by modern methods and aggressive tactics. Exchanges can no longer dictate to the markets which tech- nology they should use, and they certainly shouldn't tell them where to trade.

It is hardly surprising that exchanges move more slowly than markets, but realis- ing that they are being attacked from both sides — externally from technology and internally by governance — they have at last been modernising their ownership structure. This process, laudable in itself, has some temporary ossifying conse- quences. In the run-up to demutualisation or listing, the exchanges exaggerate their value. Students of irony enjoy the antics of those which, so used to resisting the boasts of companies seeking listing, are now declaring their own potential at a time when the threats to their business have never been greater.

An exchange like OM Gruppen of Swe- den, the first to be publicly quoted and now more a highly valued technology com- pany, is able to send a well-armed torpedo boat chasing after the London Stock Exchange which, half way through floating itself, is boarded by the crew of a German pocket battleship owned by banks which are more interested in the strategic rather than the commercial value of the venture.

Not everyone is clear what a modern exchange is or what it is for. This leads to different models. The Frankfurt one is typical of most Continental bourses in integrating the exchange (the trading technology) with the settlement company (where all the bits of paper are pushed around) with the clearing house (which collects all the money in one place). Inte- grated, organised and powerful: perfec- tion. But not what the markets say they need.

They don't want exchanges to lord it over the settlement companies, which should be free and encouraged to amalga- mate. They want their money in fewer places, not more. In that way they can put together streams of money from activities other than equities to manage their risks much more effectively and to make huge savings in capital by netting out one pot of money against another.

So the great vision of a pan-European market in equities is bedevilled by exchanges moving at different speeds, with different ownership structures and differ- ent ideas on what an exchange should be. That is just a start. Try harmonising the regulatory, tax and legal issues.

Fortunately, the international markets in London, with their less tidy, even anarchic, approach, are in better shape. They know that they, not the British or the Germans, own and influence all the separate compo- nents. They will find a way. Visions so beloved by exchanges will give way to the brutal pragmatism of the markets. They will give the exchanges a little longer to sort themselves out, but not long. If the obstacles in their way are not flattened, the markets will find a way round. They have two things going for them: technology and innovation.

It used to be the exchanges that devel- oped the trading systems. Now a plethora of technology companies provide new sys- tems. London's Liffe may have the dis- tinction of being the last major exchange to design its own technology, and even that is now being developed and adapted for other businesses by a partnership with one of the world's largest technology companies, Cap Gemini Ernst and Young. It is companies such as these that will produce the systems the major finan- cial firms require, and the exchanges that survive are those which forge the right partnerships with these firms, not with other exchanges.

Technology is the driving force behind world markets, and embracing it may save an exchange from oblivion, but smart thinking is needed as well. It is essential in the quest for closing the cost and effi- ciency gap between the European and American equity markets. The greatest successes sometimes come from unlikely sources. Who would have thought that Nasdaq — on some days the biggest stock market in the world — would have grown out of an organisation designed to regu- late the securities industry? Who would have spotted more than 25 years ago that the money and bond markets would be revolutionised by some cattle and grain traders in Chicago?

Markets don't always get it right. They laughed when they were told that you could sell a bank deposit without owning one or trade a government stock that didn't exist. Exchanges proved them wrong. Last week it was a European exchange (well, all right then, a London exchange) that suggested a global market in artificial equities will come with all the characteristics of the real thing but none of the problems. Maybe exchanges are not dead yet. Until, of course, someone sug- gests the synthetic annual dinner.