Australia | Sep 12 2006
By Greg Peel
It is one of the great hypocrisies of the present government and its subsidiary, the ACCC, that some businesses are permitted to act as monopolies and others aren’t.
Hence we have a telco fighting for its life under oppressive government regulation enacted to ensure National Party seats are maintained at the expense of the telecommunication capacity of 90% of the population who live in cities.
At the same time we have a national airline that can rely on the government to bar competition on specific routes, ensuring ticket prices across the Pacific remain onerous for the average Australian.
And we also have a now privatised stock exchange with an effective monopoly to charge whatever prices it likes, and which has been permitted to merge with the only other financial exchange of global consequence, the SFE.
Little wonder the investment community is peeved.
The government could argue that there has been no viable contender to the position of the ASX (ASX), so it would be pointless to upset the entire national stock market just to ensure competition. As to why the SFE merger sailed through is by the by. Nevertheless, the government will probably be pleased to hear that the ASX monopoly is to be challenged, if for no other reason than to save face.
Dissatisfaction with the ASX’s pricing monopoly runs deep. And so it is that five of Australia ‘s major investment banks, and the New Zealand Exchange (ASX: NZX), have joined together to create an Electronic Communications Network, or ECN, in order to challenge the ASX’s incumbency.
Those five banks– SB Citigroup, CommSec, GSJB Were, Macquarie Bank and Merrill Lynch – are all top ten brokers in Australia. Together with ABN Amro, Deutsche Bank, JP Morgan, Credit Suisse and UBS they command 75% of market turnover.
The initial intention of the ECN, known as NewCo ECN and 50% owned by the banks and 50% owned by the NZE, is only to facilitate crossing trades, which represent roughly 30% of daily turnover.
Under the ASX rules, if a broker holds equivalent buy and sell orders from two different clients it can “cross” those trades in a transaction known as a “special” provided the value of the trade exceeds $1 million. Otherwise the “cross” has to be performed in the market, which means existing bids or offers from other brokers have to be satisfied first. This usually results in part of the cross being left unfulfilled.
The idea of the “special’ is not to shut out the rest of the market, but simply to facilitate large trades without the inconvenience of small retail lines getting in the way. The cross is a zero sum result in terms of price direction, and is fully disclosed to the market anyway. Crossed trades usually emanate from institutional portfolio readjustment on one side, and either the same, but opposite, on the other side, or often the broker’s proprietary desk.
Institutional trading is the big money spinner for brokers, but the margins are very tight. Thus the fee placed on crossing trades by the ASX is a bone of contention when two consenting adult clients have agreed to trade without the need for anything more than the clearing house function. This is why the NewCo ECN is attacking crossings first.
The brokers in the FN Arena database are almost all the same names you see above. Thus it is amusing to read what the analysts employed by those brokers think about the challenge to the stock they are providing analysis for – the ASX. In short, no one thinks it will make any real difference, at least in the short term.
The world is already littered with ECNs, and they have all found it extremely difficult to break the stranglehold the incumbent exchange enjoys on a particular market. In the US, for example, there are several stock exchanges, yet the NYSE still conducts 80% of the business.
While an ECN might allow brokers to cross trades more freely at a reduced cost, the fact remains (a) that all trades will still have to be cleared through the ASX monopoly clearing system – CHESS – and (b) splitting liquidity between two exchanges only undermines efficient trading and price discovery for both.
Analysts agree that in reality, the ECN will likely only affect a 3-4% profit reduction for the ASX, and that the ASX will likely absorb this by simply matching costs. In other words, it’s all a storm in a tea cup as far as the ASX is concerned.
However, most analysts point out that the situation could be different if the new exchange spends a good deal of money and moves beyond facilitating crossing trades alone. If it establishes a foothold, this could well undermine the ASX’s pricing power and profitability in the longer term. This would only occur some time down the track, and the track record of start-up exchanges is very poor. (Mind you, few start ups have had the weight of several of the world’s largest investment banks behind them).
The FN Arena database shows the ASX on a 6/3/1 ratio of Buy/Hold/Sell ratings. The ECN backers are split across Buy and Hold, while Credit Suisse is the only Sell, believing the stock to be fully priced at present.