Korea Capital Market Institute

Ⅰ. Introduction The capital market is in an era of rapid change. It is getting larger, more efficient, more globalized. Reg NMS and MiFID have been making significant and systematic changes in the market micro- and macro-structure. Alternative trading venues are recognized as markets and are competing for liquidity with traditional securities exchanges. Moreover, innovations and improvements in financial IT enable the expansion of algorithm trading, high frequency trading, and DMA, which all strengthen competition among trading venues. To cope with the competitive environment, traditional exchanges, which were originally not-for-profit entities, had to demutualize and list. Entering the 2000s, several securities exchanges went through M&As and alliances to raise their competitiveness. Although the Korea Stock Exchange (KRX) has a monopoly status in the Korean securities market under the current laws, the KRX is not free from global competitive pressure. The technological, regulatory, and competitive environment surrounding the Korean capital market is changing. In this paper, we analyze the foreign securities exchanges’ M&A cases, and then we derive implications for the Korean capital market. Ⅱ. Exchange M&A trends M&As among securities exchange can be classified as a functional type or regional type. The functional type is further divided into vertical integration and horizontal integration, and the regional type is divided into inter-region integrations and intra-region integrations. There are four kinds of horizontal integration which are M&As between stock exchanges, between derivative exchanges (including futures, options, bonds, commodity, or other derivatives exchange), between a stock exchange and a derivative exchange, and between clearing, settlement, and custodian institutions. There are three kinds of vertical integration which are M&As between a stock exchange and a clearing, settlement, and custodian institution, between a stock exchange and an IT service company, and between a derivatives exchange and an IT service company. Intra-region M&As have subsets such as the Europe region, north America region, south America region, Asia region, and Africa region M&As. Inter-region M&As have subsets such as Europe-north America and Europe-Asia inter-region M&As. Among the 73 M&As during our research period of 2000~2009, there were 43 cases of horizontal integration and 28 cases of vertical integration. The remaining 2 cases were vertical and horizontal integration between a stock exchange, a derivatives exchange, and an IT service company. About a half of horizontal integration cases are the M&As between stock exchanges and most vertical integrations are M&As between a stock exchange and an IT service company. Looking at the regional type, 25, 23, and 15 cases were completed in Europe, North America, and Asia region respectively. There were 6 inter-regional M&As. The M&As in the exchange industry are mostly inter-country cases in Europe, whereas in Asia and North America most of them are intra-country M&As. However, the M&As in Europe and North America are mostly horizontal but those in Asia are mostly vertical. Rather than doing an M&A, some exchanges form strategic alliances or take partial equity ownership over another exchange or exchange business related companies. During the research period, 237 alliances and 68 partial equity ownership acquisitions were made by securities exchanges. Most alliances and partial equity ownership acquisitions were conducted by Asian exchanges. Usually, alliances are horizontal and partial stock ownership acquisitions are vertical. Exchange M&A is still in progress. If exchange M&A can promote exchange services’ efficiency and raise market power, M&As will continue to increase. In fact, the Asian market might be the focus in the near future. Ⅲ. Background of the exchange M&A There are several theories that explain the motives for exchange M&As. According to the efficiency theory, exchange M&As are expected to generate operational, financial, and managerial synergy. The network externality theory argues that the main motive of exchange M&As is increased liquidity from network externality. So securities exchanges strive to acquire larger investor base and listing companies through an M&A. The resource based view argues that small and under-developed exchanges will choose an M&A to acquire inimitable assets such as another exchange’s reputations or traditions. According to the organizational learning theory, securities exchange looks for M&As or alliances to acquire tacit knowledge necessary for exchange operations which is hard to attain through a contract or market mechanism. Lastly, the institutional theory claims that exchanges undergo M&As to mimic other major exchange`s strategy or to meet customers` demand. Several factors are behind the exchange M&A trend. Demutualization and listing of exchanges, development of financial IT, and regulatory changes such as MiFID or Reg NMS among others have largely fostered this trend by strengthening competition in the exchange industry. Exchange M&As are expected to generate an economy of scale, to diversify investment products, and to increase market liquidity. The economy of scale lowers the service costs and then provides cost efficiency to market participants. Diversified investment products guarantee a better portfolio diversification and lead to more innovative financial products and services. Lastly, liquidity enhancement can build up the market’s price discovery function, lower the cost of capital and reduce the investors` implicit trading costs. It can ultimately improve the efficiency of resource allocation in the economy. Ⅳ. Case study on exchange M&As We analyze 10 representative exchange M&A cases. We select the NYSE-Euronext case and NASDAQ-OMX case as the biggest examples of inter-region M&A. The LSE case and TSX case are used for the intra-region M&A in Europe and North America respectively. For derivatives exchange M&As, CME and Eurex are selected; for clearing institutions M&As, the Euroclear case is used. The mergers by SIX Swiss and ICE are the best examples for vertical integration. The Bursa Malaysia case is included to represent M&As in the Asian market. For these cases, we investigate the background and the deal’s details and try to evaluate the consequence of the M&A. Ⅴ. Implications for the KRX Exchange M&As emerged in 2000s. So it seems premature to talk about their success at this time. However, it is very important for the KRX to analyze and learn from exchange M&A trends because it has to compete with global exchanges in the near future. As the block economy advances in Asia, exchange M&As will increase in the region. Alliances and partial equity ownership acquisition of Asian exchanges may evolve towards M&As. The KRX has to prepare for the upheaval in the Asian exchange industry by exploring a wide range of M&A possibilities. It is noteworthy that IPOs will be a turning point for the KRX. Through IPOs, the KRX can raise funds for improving exchange services, enhance managerial efficiency by improving corporate governance, and prepare for possible M&As.