The nationalist undertone in thwarted bids shows that governments and regulators view the stock exchange as a key infrastructure facility that needs to be under local control.

The year 2011 has not been good for the stock exchanges on multiple fronts. They have been grappling with investor apathy resulting in declining volumes. Those exchanges that wanted to grow through the merger route had to retract as these transactions were stonewalled by the respective governments, shareholders or for other reasons. So what is the way forward for exchanges in the current situation?

Pockets of growth

It is broadly agreed that the developed economies will witness slower growth in equity trading in the years to come as the equity culture has penetrated relatively deeper in these regions. According to World Federation of Exchanges, of the total traded value on the exchanges across the globe, NYSE Euronext Group accounts for 28 per cent and NASDAQ OMX group accounts for 20 per cent.

Exchange giants such as these need to look at fresher pastures if they want to grow at a decent clip.

The exchanges that are exhibiting potential to grow at a fast rate are mostly located in the emerging or frontier markets.

In the year 2010, increase in traded value in the capital market segment of exchanges was between 30 and 70 per cent in emerging markets such as Brazil, Indonesia, the Philippines and Thailand. It is therefore not surprising that exchanges in developed regions would look to these growth engines to add to their revenues.

But the debacle of the last two high-profile merger attempts between exchanges could be setting a precedent for the future mergers in this industry.

The Singapore stock exchange's bid to merge with Australian stock exchange was foiled this year when Australian Treasurer Mr Wayne Swan rejected the proposed merger arguing it was not in the national interest.

Mergers made difficult

Similar bid by London Stock Exchange Group (LSEG) to merge with Toronto exchange received a volley of protest again on the basis that it would compromise domestic interest. The deal was called off just before it was to go in for voting by the shareholders since it was felt that the plan would not obtain the required two-third majority.

Another foiled attempt at exchange merger this year was the NASDAQ OMX Group's bid for NYSE Euronext.

The deal was called off after US department of Justice threatened to file an anti-trust lawsuit to block the deal as it would eliminate competition in stock trading activity which would be detrimental to investors.

The nationalist undertone in the thwarted bids cited above only underlines the importance that governments and regulators place on stock exchanges.

Capital markets are the main source through which companies can raise capital in any country. The fear that if the control is passed on to foreign hands, then it could become relatively more difficult for domestic companies to raise funds seems to be the reason why the Australians and Canadians acted that way.

Most other countries too seem to concur that stock exchanges are an important infrastructure facility that needs to be under local control.

Keeping this factor in view, many exchanges have set ceiling on shareholding. For instance, Australian Stock Exchange has a 15 per cent ceiling that can be raised if it is ratified by the government.

Singapore Stock Exchange has a 5 per cent limit that can be raised to 10 per cent with approval of the Monetary Authority of Singapore.

Where does India stand?

Other Asian exchanges such as Hong Kong Exchange, Philippines Stock Exchange and Tokyo Stock Exchange also have restrictions ranging between 5 and 20 per cent.

India too has 5 per cent ceiling on shareholding in stock exchanges, but institutions such as stock exchanges, depositories, clearing corporations, banks and insurance companies can hold up to 15 per cent stake.

Foreign investment up to 49 per cent is allowed in stock exchanges with Foreign Direct Investment (FDI) cap of 26 per cent and Foreign Institutional Investment (FII) cap of 23 per cent.

These restrictions act as a block against a large global exchange seeking to merge with any of our domestic exchanges or control of any of our exchanges passing to foreign companies or institutions. But this has not stopped other exchanges from seeking a foothold in to India.

Deutsche Boerse AG and Singapore Exchange hold around 5 per cent each of BSE's stake.

NYSE Euronext that held 5 per cent stake in NSE offloaded its holding to Singapore government's investment arm Temasek Holding last May.

Other foreign investors including Goldman Sachs and George Soros too hold shares in the country's exchanges.

Exchange mergers have many benefits including cost reduction resulting from shared facilities and a bolstered offering of products for investors. However it is obvious that Indian bourses can not grow through merger with another large exchange.

The wave of patriotism unleashed by the two thwarted exchange-merger bids this year drive home the point that smaller exchanges would find it difficult to obtain regulatory and government sanction to take the inorganic route to growth.

Way forward

Exchanges can, however, enter in to deals with other exchanges such as the recent deal between NSE and CME to cross-list products that culminated with the Dow and S&P futures trading on Indian bourses.

The recent agreement by BRICS exchanges to cross-list index futures is also a case in point.

The easiest way for the Indian exchanges to expand would, however, be through increasing the domestic investor base and this would not difficult given the low penetration of equity cult in our country.

(This article was published on October 29, 2011)
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