Australia’s Federal Government was never going to approve Singapore Exchange’s A$8.4 billion (US$9.18 billion) bid for ASX, the operator of the Australian Securities Exchange, in the current political climate.
The Labor government, with public support at 15-year lows, rules with the support of independent members of parliament. It is fighting massive public battles with business and unions over the introduction of a carbon tax, tough anti-smoking laws, and anti-poker (gaming) machine legislation.
In that situation, Labor concluded the obvious: approving an effective foreign takeover of Australia’s stock exchange carried too great a risk of triggering an emotive, nationalistic backlash.
Federal treasurer Wayne Swan killed the deal – announced in October last year – on April 8 after the Foreign Investment Review Board (FIRB) advised it was against Australia’s national interest. He said the benefits of the takeover to the nation were overstated. He also expressed his concerns about the loss of regulatory sovereignty over the ASX’s clearing and settlement operations and has announced an inquiry by the Council of Financial Regulators.
Critics have said the decision was purely political, and that it could discourage foreign investment into Australia and risk marginalising the ASX as exchanges merge globally.
What is certain is that Swan’s ruling has denied the ASX a major growth opportunity. The inquiry into clearing and settlement, in particular, raises the risks for the company, as the conclusion could be to divorce it from these operations.
At the same time, the ASX faces the appointment of a new chief executive and the end of its securities monopoly, with the entry of competitors, including alternative electronic exchange Chi-X this year.
Some analysts say Swan’s decision means a merger between the ASX and another international exchange is unlikely, at least in the near term. But the pressures to merge and the benefits of a merger – particularly with SGX – are not going away.
It is really only a matter of time before the ASX finds another partner, or has a second shot at tying up with the SGX.
“You’ve got to think the ASX and SGX may continue to look at avenues to get together,” said Angus Gluskie, managing director and chief investment officer of White Funds Management. “That’s a high probability.”
Swan’s rejection is likely to be a step in a long road to consummation between the ASX and another exchange. And for all the government’s current opposition, the SGX remains the most likely candidate.
An array of alliances
The proposed ASX/SGX deal was part of a seemingly unstoppable trend for international exchanges to merge.
In February, the London Stock Exchange (LSE) bid for TMX Group, which operates the Toronto Stock Exchange; and Deutsche Börse has sought to merge with NYSE Euronext, which has rejected another offer from Nasdaq OMX Group and IntercontinentalExchange.
Like the ASX/SGX, both deals have triggered controversy and concerns over loss of exchange sovereignty.
But most of today’s acquisition-minded exchanges are already the product of a wave of mergers. The LSE bought Borsa Italiana in 2007; the NYSE bought Euronext in 2006 (the latter had already been formed in 2000 by a merger between the Paris Bourse, Amsterdam Stock Exchange and Brussels Stock Exchange, and in 2002 merged with the Portuguese exchange); and OMX was acquired by Nasdaq in 2008 (having been formed from combining exchanges including those of Stockholm, Helsinki, Copenhagen).
Exchanges have sought to bulk up through mergers to create scale and drive down costs. This has come amid increased competition from alternative electronic exchanges, such as Chi-X, which are looking to undercut primary exchanges and offer trading in the most liquid stocks.
But J.P. Morgan analyst Russell Gill notes that Asian exchanges, including the ASX, are somewhat different from those in North America and Europe.
“[North American exchanges] generate far more revenue from the cash-market trading functions, which makes them more vulnerable to competition [such as Chi-X],” he says. “Asian exchanges [including the ASX] are much more diversified and earn much more revenue from clearing and settlement and derivatives.”
Gill notes that many exchanges around the world are now looking to ape such diversified models.
“If you look at the recent commentary coming from the exchanges in Europe, post-trade services (such as clearing) are becoming a much more important area with a couple of European exchanges, signalling that they may wish to move back towards a vertically integrated model and self-clear cash-market trades in the future,” he says.
It was, however, partly that very diversification of ASX’s operations that caused Swan to kill the SGX deal. He said he knocked back the takeover firstly because the opportunities created were not enough to justify loss of economic and regulatory sovereignty over the ASX. He cited, for example, the fact that SGX is a smaller exchange and has a smaller equities market than the ASX.
The Australian treasurer also had major concerns about loss of regulatory sovereignty over Australia’s financial infrastructure, including the ASX’s clearing and settlement functions – the very operations that make the ASX more diversified and less vulnerable to the impact of new competition.
Swan said that regulators had advised him that reforms of regulations covering that financial infrastructure were needed to ensure regulatory risks were minimised should the ASX tie up with another exchange.
Splitting out settlement?
In rejecting the takeover, Swan announced an inquiry into regulations. Some media commentators have speculated the government could use this to force the ASX to divest its settlement and clearing functions.
But such a split would entail considerable practical difficulties. In a note to clients, Gill highlighted that the ASX has two clearing businesses: one related to derivatives; the other to the cash market. If the ASX were forced to divest its derivatives clearing business, it would effectively re-split into the ASX and Sydney Futures Exchange – a move back to the situation prior to its mid-2006 merger.
Gill says most of the value of the ASX’s derivatives business is in its clearing function: “That is where the intellectual property around understanding volatility and managing risk comes into play.”
Splitting the cash-market clearing and settlements would also be difficult. The government would have to come up with an alternative ownership structure: either government ownership, which is unlikely; a separately listed vehicle, which would increase trading costs; or user ownership (selling back to the brokers).
“If the government’s concern is that ownership of these functions should not be placed in ‘foreign hands’ (i.e., ‘sold’ to SGX) then it does not make much sense to be selling these functions back to the users in the Australian cash market, [where] the majority [of] turnover [is] coming from…subsidiaries of US and European banks,” says Gill.
White Fund Management’s Gluskie agrees that major changes, including forced divestment, are unlikely to emerge from the Council of Financial Regulators review.
“I think at this stage it’s probably unlikely the government would move to excessively fragment or hinder the ASX in its operations by virtue of the regulatory review,” he says. “The government showed a willingness to protect the ASX and its ability to operate here in the Australian market. I don’t think they’re likely to make dramatic change.”
Seeking a successor
The ASX’s immediate priority is to find a successor to CEO Robert Elstone, whose term ends in July.
Magnus Böcker, the SGX CEO, had been proposed as CEO of the merged ASX-SGX Group. An ASX spokesman says Elstone has agreed to extend his term for up to three months to ensure a smooth transition, adding that the search for a new CEO had just begun with more detail to be provided in the coming months.
The new CEO will be immediately forced to deal with competition from Chi-X, which starts operating as early as October. Deutsche analyst Kieren Chidgey, in a note to clients, estimates that the ASX will lose 25% of equity-trading market share over two years, which comprises just 6.5% of full-year 2011 group revenue.
“Given a likely rise in trading velocity from competition, revenue impacts are likely to be small in our view,” he said.
But Mark Daniels, head of Australian equities at fund manager Aberdeen Asset Management, believes the impact from Chi-X will not be immaterial – and will grow over time.
“It is attacking a small part of the ASX business, but it will have an impact,” he says. “The impact might be relatively minimal to start with, but 10 years down the line, or even five years down the line, it tends to have much more of an impact.”
Gluskie agrees that the ASX is moving to crunch time when it comes to competition. “[Competition] is a given,” he says. “We certainly would want to see the ASX react appropriately so it minimises the impact.”
But how do they do that? New ASX initiatives include a state-of-the-art data centre, and PureMatch, a trade-execution facility designed for high-frequency traders.
“They need to make themselves as efficient as possible so they can compete on a price basis,” Gluskie adds. “An aspect of that is the potential to look at mergers or strategic partners to lower operating costs.”
Seeking a new relationship
It’s ironic that for all the difficulties raised by the SGX’s proposed alliance, the ASX can best secure its future by finding a new merger or strategic partnership.
But it will not be easy. J.P. Morgan’s Gill says that the majority of strategic relations between exchanges globally have not produced much upside unless there has been a transfer of equity ownership.
And as the ASX has discovered, that complicates things. When exchanges agree to get together and create a platform, it is a delicate process as both companies have different investment profiles, board members and growth profiles.
“The national or home priorities tend to take precedence,” he says.
The creation of derivatives bourse Eurex (an alliance between SIX Swiss Exchange and Deutsche Börse) is one of the few successful joint ventures of any size between two exchanges, where ownership is 50:50.
“But generally it hasn’t really worked globally; it always sounds good and is good to talk about,” Gill says, noting that the SGX and the ASX already spent millions of dollars looking at a strategic partnership seven years ago.
The ASX knows that it can’t give up its search for a partner. After the rejection of the SGX deal, it reiterated in a statement its ongoing belief that it needs to participate in regional and global exchange consolidation.
“ASX will continue to evaluate strategic growth opportunities, including further dialogue with SGX on other forms of combination and cooperation,” it said. The ASX spokesman would not comment further.
Gluskie believes the likelihood is high of a merger or tie-up between the ASX and another exchange, and maintains that there are other ways to conduct a union that would not raise as many political hackles.
“There’d still be a 75% to 85% chance we see a tie-up between the ASX and another exchange,” he says. “The government was coming from a paternal perspective. They felt this was more of a one-sided takeover where some of the proprietary rights associated with exchanges that relate to Australia were lost.”
“A merger of equals is a path open for the ASX to tie up with others,” he adds, predicting action in this space in the next two to three months.
Gill is less optimistic. He notes that given Swan’s problems with the deal it is unlikely to be reworked in a new format any time soon. He also does not believe the government would be happy for a transaction to go through before its financial infrastructure inquiry is complete.
“Given the nationalistic nature of stock exchanges, public perception to these types of transactions will take a while to change,” Gill says. “The current political environment in Australia is not conducive to the approval of an ASX transaction with an offshore exchange. That perception has to change.
“It’s likely to change over the coming years as exchange mergers continue in other regions around the world. But we’re talking a couple of years. Sentiment is not a thing you can change very quickly.”
Lack of alternatives
When the ASX does finally show signs of transforming, it could well be other Asian exchanges, such as Hong Kong, that are most likely to be open to a tie-up.
“Equally, there are European and US exchanges who are increasingly looking at their overall global exposures,” says Gluskie. “I don’t think you can rule them out.”
But Alex Frino, professor at the School of Business at the University of Sydney, has noted that few exchanges are big enough to bid for the ASX.
With a market capitalisation of around US$6 billion, the ASX is bigger than the Nasdaq/OMX and the LSE. Frino notes that, in the wake of their merger, Deutsche Börse and NYSE Euronext will probably not be interested in another for many years. That leaves the Hong Kong Stock Exchange, which he feels is unlikely to present a greater “national-interest value” than the already unsuccessful SGX.
Despite Swan’s rejection of the deal, it seems the SGX is likely to remain the front-runner to merge, or at the very least partner, with the ASX.
“I think they [ASX] will immediately and very actively look at the major areas of government concern and then look at how they can tinker with the current merger with SGX, or structure a new merger or tie-up with another exchange in a manner whereby they can then present a palatable structure,” Gluskie says.
J.P. Morgan’s Gill agrees that it is just a matter of time. “A deal [between the SGX and ASX] will probably be revisited in the future, just not in the near term.”
Failure of the alliance between the ASX and SGX may have been inevitable, but almost as probable is a resurrection of the selfsame deal. There are not too many other options for either bourse.