on a recognized exchange. They also demanded rules for the disclosure of

trades and prices that would have hamstrung SEAQ's quote-driven trading

system. They were beaten off in the eventual compromise, partly because

governments realized they risked driving business outside the EC. But

residual attempts to stifle competition remain. Italy passed a law in 1991

requiring trades in Italian shares to be conducted through a firm based in

Italy. Under pressure from the European Commission, it may have to repeal

it.

6.1 New Ways for Old

The second response to competition has been frantic efforts by bourses

to modernize systems, improve services and cut costs. This has meant

investing in new trading systems, improving the way deals are settled, and

pressing governments to scrap stamp duties. It has also increasingly meant

trying to beat London at its own game, for instance by searching for ways

of matching London's prowess in block trading.

Paris, which galvanized itself in 1988, is a good example. Its bourse

is now open to outsiders. It has a computerized trading system based on

continuous auctions, and settlement of most of its deals is computerized.

Efforts to set up a block-trading mechanism continue, although slowly.

Meanwhile, MATIF, the French futures exchange, has become the continent's

biggest. It is especially proud of its ecu-bond contract, which should grow

in importance if and when monetary union looms.

Frankfurt, the continent's biggest stock-market, has moved more

ponderously, partly because Germany's federal system has kept regional

stock exchange in being, and left much of the regulation of its markets at

Land (state) level. Since January 1st 1993 all German exchanges (including

the DTB) have been grouped under a firm called Deutsche Borse AG, chaired

by Rolf Breuer, a member of Deutsche Bank’s board. But there is still some

way to go in centralizing German share-trading. German floor brokers

continue to resist the inroads made by the bank’s screen-based IBIS trading

system. A law to set up a federal securities regulator (and make insider-

dealing illegal) still lies becalmed in Bonn.

Other bourses are moving too. Milan is pushing forward with screen-

based trading and speeding up its settlement. Spain and Belgium are

reforming their stock-markets and launching new futures exchanges.

Amsterdam plans an especially determined attack on SEAQ. It is implementing

a McKinsey report that recommended a screen-based system for wholesale

deals, a special mechanism for big block trades and a bigger market-making

role for brokers.

Ironically, London now finds itself a laggard in some respects. Its

share settlement remains prehistoric; the computerized project to modernize

it has just been scrapped. The SEAQ trading system is falling apart; only

recently has the exchange, belatedly, approves plans draw up by Arthur

Andersen for a replacement, and there is plenty of skepticism in the City

about its ability to deliver. Yet the exchange’s claimed figures for its

share of trading in continental equities suggest that London is holding up

well against its competition.

Are these figures correct? Not necessarily: deals done through an agent

based in London often get counted as SEAQ business even when the

counterpart is based elsewhere and the order has been executed through a

continental bourse. In today’s electronic age, with many firms members of

most European exchanges, the true location of a deal can be impossible to

pin down. Continental bourses claim, anyway, to be winning back business

lost to London.

Financiers in London agree that the glory-days of SEAQ’s international

arm, when other European exchanges were moribund, are gone. Dealing in

London is now more often a complement to, rather than a substitute for,

dealing at home. Big blocks of stock may be bought or sold through London,

but broken apart or assembled through local bourses. Prices tend to be

derived from the domestic exchanges; it is notable that trading on SEAQ

drops when they are closed. Baron van Ittersum, chairman of the Amsterdam

exchange, calls this the “queen’s birthday effect”: trading in Dutch

equities in London slows to a trickle on Dutch public holidays.

Such competition-through-diversity has encourage European exchanges to

cut out the red tape that protected their members from outside competition,

to embrace electronics, and to adapt themselves to the wishes of investors

and issuers. Yet the diversity may also have had a cost in lower liquidity.

Investors, especially from outside Europe, are deterred if liquidity

remains divided among different exchanges. Companies suffer too: they

grumble about the costs of listing on several different markets.

So the third response of Europe’s bourses to their battle has been pan-

European co-operative ventures that could anticipate a bigger European

market. There are more wishful words here than deeds. Work on two joint EC

projects to pool market information, Pipe and Euroquote, was abandoned,

thanks mainly to hostility from Frankfurt and London. Eurolist, under which

a company meeting the listing requirements for one stock exchange will be

entitled to a listing on all, is going forward–but this is hardly a single

market. As Paris’s Mr Theodore puts it, "there is a compelling business

case for the big European exchanges building the European-regulated market

of to-morrow" Sir Andrew Hugh-Smith, chairman of the London exchange has

also long advocated one European market for professional investors

One reason little has been done is that bourses have been coping with

so many reforms at home. Many wanted to push these through before thinking

about Europe. But there is also atavistic nationalism. London, for example,

is unwilling to give up the leading role it has acquired in cross-border

trading between institutions; and other exchanges are unwilling to accept

that it keeps it. Mr. Theodore says there is no future for the European

bourses if they are forced to row in a boat with one helmsman. Amsterdam's

Baron van Ittersum also emphasises that a joint European market must not be

one under London's control.

Hence the latest, lesser notion gripping Europe's exchanges: bilateral

or multilateral links. The futures exchanges have shown the way. Last year

four smaller exchanges led by Amsterdam's EOE and OM, an options exchange

based in Sweden and London, joined together in a federation called FEX In

January of this year the continent's two biggest exchanges, MATIF and the

DTB, announced a link-up that was clearly aimed at toppling London's LIFFE

from its dominant position Gerard Pfauwadel, MATIF's chairman, trumpets the

deal as a precedent for other European exchanges. Mr Breuer, the Deutsche

Borse's chairman, reckons that a network of European exchanges is the way

forward, though he concedes that London will not warm to the idea. The

bourses of France and Germany can be expected to follow the MATIF/DTB lead.

It remains unclear how such link-ups will work, however. The notion is

that members of one exchange should be able to trade products listed on

another. So a Frenchman wanting to buy German government-bond futures could

do so through a dealer on MATIF, even though the contract is actually

traded in Frankfurt. That is easy to arrange via screen-based trading: all

that are needed are local terminals. But linking an electronic market such

as the DTB to a floorbased market with open-outcry trading such as MATIF is

harder Nor have any exchanges thought through an efficient way of pooling

their settlement systems

In any case, linkages and networks will do nothing to reduce the

plethora of European exchanges, or to build a single market for the main

European blue-chip stocks. For that a bigger joint effort is needed It

would not mean the death of national exchanges, for there will always be

business for individual investors, and in securities issued locally Mr

Breuer observes that ultimately all business is local. Small investors will

no doubt go on worrying about currency

risk unless and until monetary union happens. Yet large wholesale

investors are already used to hedging against it. For them, investment in

big European blue-chip securities would be much simpler on a single

wholesale European market, probably subject to a single regulator

More to the point, if investors and issuers want such a market, it will

emerge—whether today's exchanges provide it or not. What, after all, is an

exchange? It is no more than a system to bring together as many buyers and

sellers as possible, preferably under an agreed set of rules. That used to

mean a physically supervised trading floor. But computers have made it

possible to replicate the features of a physical exchange electronically.

And they make the dissemination of prices and the job of applying rules to

a market easier.

Most users of exchanges do not know or care which exchange they are

using: they deal through brokers or dealers. Their concern is to deal with

a reputable firm such as S. G. Warburg, Gold-man Sachs or Deutsche Bank,

not a reputable exchange. Since big firms are now members of most

exchanges, they can choose where to trade and where to resort to off-

exchange deals—which is why there is so much dispute over market shares

within Europe This fluidity creates much scope for new rivals to undercut

established stock exchanges.

6.2 Europe, Meet Electronics

Consider the experience of the New York Stock Exchange, which has

remained stalwartly loyal to its trading floor. It has been losing business

steadily for two decades, even in its own listed stocks. The winners have

included NASDAQ and cheaper regional exchanges. New York's trading has also

migrated to electronic trading systems, such as Jeffries & Co's Posit,

Reuters's Instinct and Wunsch (a computer grandly renamed the Arizona Stock

Exchange).

Something similar may happen in Europe. OM, the Swedish options

exchange, has an electronic trading system it calls Click. It recently

renamed itself the London Securities and Derivatives Exchange. Its chief

executive, Lynton Jones, dreams of offering clients side-by-side on a

screen a choice of cash products, options and futures, some of them

customised to suit particular clients The Chicago futures exchanges,

worried like all established exchanges about losing market share, have

recently launched "flex" contracts that combine the virtues of homogeneous

exchange-traded products with tailor-made over-the-counter ones.

American electronic trading systems are trying to break into European

markets with similarly imaginative products Instinet and Posit are already

active, though they have had limited success so far. NASDAQ has an

international arm in Europe. And there are homegrown systems, too.

Tradepoint, a new electronic order-driver trading system for British

equities, is about to open in London. Even bond-dealers could play a part.

Their trade association, ISMA, is recognized British exchange for trading

in Eurobonds; it has a computerized reporting system known as TRAX; most of

its members use the international clearing-houses Euroclear and Cedel for

trade settlement. It would not be hard for ISMA to widen its scope to

include equities or futures and options. The association has recently

announced a link with the Amsterdam Stock Exchange.

Electronics poses a threat to established exchanges that they will

never meet by trying to go it alone. A single European securities market

(or derivatives market) need not look like an established stock exchange at

all. It could be a network of the diverse trading and settlement systems

that already exists, with the necessary computer terminals scattered across

the EC. It will need to be regulated at the European level to provide

uniform reporting; an audit trail to allow deals to be retraced from seller

to buyer; and a way of making sure that investors can reach the market

makers offering the best prices. Existing national regulators would prefer

to do all this through co-operation; but some financiers already talk of

need for a European SEC. An analogy is European civil aviation’s reluctant

inching towards a European system of air-traffic control.

Once a Europe-wide market with agreed regulation is in place,

competition will window out the winners and losers among the member-

bourses, on the basis of services and cost, or of the rival charms of the

immediacy and size of quote-driven trading set against the keener prices of

order-driven trading. Not a cosy prospect; but if the EC’s existing

exchanges do not submit to such a European framework, other artists will

step in to deny them the adventure.

7. NEW ISSUES

Up to now, we have talked about the function of securities markets as

trading markets, where one investor who wants to move out of a particular

investment can easily sell to another investor who wishes to buy. We have

not talked about another function of the securities markets, which is to

raise new capital for corporations–and for the federal government and state

and local governments.

When you buy shares of stock on one of the exchanges, you are not

buying a “new issue”. In the case of an old established company, the stock

may have been issued decades ago, and the company has no direct interest in

your trade today, except to register the change in ownership on its books.

You have taken over the investment from another investor, and you know that

when you are ready to sell, another investor will buy it from you at some

price.

New issues are different. You have probably noticed the advertisements

in the newspaper financial pages for new issues of stocks or bonds–large

advertising which, because of the very tight restrictions on advertising

new issues, state virtually nothing except the name of the security, the

quantity being offered, and the names of the firms which are “underwriting”

the security or bringing it to market.

Sometimes there is only a single underwriter; more often, especially if

the offering is a large one, many firms participate in the underwriting

group. The underwriters plan and manage the offering. They negotiate with

the offering company to arrive at a price arrangement which will be high

enough to satisfy the company but low enough to bring in buyers. In the

case of untested companies, the underwriters may work for a prearranged

fee. In the case of established companies, the underwriters usually take on

a risk function by actually buying the securities from the company at a

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