Some Issues on Cross-Border Stock Exchange Mergers

University of Pennsylvania Journal of International Law, Dec 2007

Ioannis Kokkoris, Rodrigo Olivares-Caminal

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Some Issues on Cross-Border Stock Exchange Mergers

University of Pennsylvania Journal of International Law BY IOANNIS KOKKORIS 0 RODRIGO OLIVARES-CAMINAL 0 0 . Principal Case Officer at the Office of Fair Trading (UK), Visiting Lecturer at City University (UK), and Visiting Fellow at the University of Durham (UK). The is Globalization,internationalization,integration, deregulation, as well as technologicaladvances have provided the impetus for mergers of stock exchanges to facilitate cross-border listings and trading. Cross-border mergers triggera series of different issues to be analyzed. The focus of our analysis will be on regulatory and competition law issues arisingfrom cross-borderstock exchange mergers. From a competition law standpoint,stock exchange mergers may have a severe impact on the competition among stock exchanges and thus lead to higherfees or lower quality of service. The focus will be on horizontal issues arisingfrom such mergers. Thus, this Article will provide an analysis of the following issues: (1) the provision of primary listing services to domestic companies; (2) the provision of secondary listing services and primarylisting services to companies seeking listings outside their domestic market; (3) the provision of on-book equities trading services; (4) markets for bonds and derivatives trading; and (5) markets for information services as well as information technology services. Some permutations of cross-border stock exchange mergers may induce competitive harm that leads to a post-merger market characterized by a lower degree of competition, and thus a lower degree of innovation and improvement in exchange services. The burdenfalls on competition authorities to ensure that effective and sufficient competition remains after any consolidationin the stock exchange industry. It should be emphasized that sound and effective regulation is the key to the development and integration of stock exchanges in the global market. Effective regulationwill provide confidence and attractinvestors, - 456 allowing stock exchanges to grow and interact. However, there is no single regulation structure that will be suitable to all countries. 1. INTRODUCTION Globalization, internationalization, integration, deregulation, and technological advances have led to legislative changes such as the Investment Services Directive ("ISD")1 and its successor, the Markets in Financial Instruments Directive ("MiFID"),2 which aim at the harmonization of regulation and have led to the creation of a new regulatory environment for capital markets in Europe. This trend has increased the number of international investors in the European capital markets and has provided impetus to mergers of stock exchanges as a means of facilitating cross-border listings and trading. Stock markets across the globe have been the subject of merger discussions following pressure to cut costs and become more competitive. Besides the New York Stock Exchange's ("NYSE") acquisition of Euronext, which operates exchanges in Paris, Amsterdam, Brussels, and Lisbon, the London Stock Exchange ("LSE") has been the subject of constant speculation since Deutsche B6rse AG launched a £1.35 billion takeover bid in December 2004. Further approaches or interest from Euronext NV, the NYSE Group Inc., Australia's Macquarie Bank Ltd., and National Association of Securities Dealers Automated Quotation System ("Nasdaq") have sent the value of the LSE rocketing. LSE's 1 Council Directive 93/22, On Investment Services in the Securities Field, 1993 O.J. (L 141) 27 [hereinafter Investment Services Directive]. The Investment Services Directive set the legislative framework for investment firms and securities markets in the European Union ("EU"), providing for a single passport for investment services, thus enabling investment firms to operate throughout the EU. The ISD has been repealed by the Markets in Financial Instruments Directive of the European Parliament and the Council of April 21, 2004. Parliament and Council Directive 2004/39, art. 69, On Markets in Financial Instruments, 2004 O.J. (L 145) 1, 39 [hereinafter Markets in Financial Instruments Directive]. 2 Markets in Financial Instruments Directive, supra note 1. The MiFID was adopted in the EU in April 2004, and its implementing measures were adopted in August 2006. Press Release, European Union, Investment Services: Final Adoption of Directive is Boost for Investment Firms and Their Clients (Apr. 27, 2004) (available at http://europa.eu/rapid/pressReleasesAction.do?reference =IP/04/546). EU member states were to incorporate the MiFID and its implementing measures into domestic legislation and rules by January 31, 2007. The legislation and rules must have been in effect by November 1, 2007. Press Release, European Union, Investment Services: Entry into Force of MiFID a Boon for Financial Markets and Investor Protection (Oct. 29, 2007) (available at http:/ /europa.eu/rapid/pressReleasesAction.do?reference=IP/07/1625). 2007] 457 shares more than tripled from 414 pence even before the Deutsche Borse approach. On June 22, 2007, the LSE agreed in principle to acquire Borsa Italiana in an all-paper transaction valued at about E1.6 billion (£1.1 billion). More recently, nearly 50 percent of the LSE went to the hands of two rival Gulf states battling to be their region's leader in the global consolidation of exchanges. Qatar Investment Authority and Borse Dubai now own 48 percent of the LSE following a complex series of deals in which ownership of Europe's exchanges is being realigned. Borse Dubai secured 28 percent of the LSE as part of a wider deal with the U.S.-based Nasdaq designed to settle their long-running battle for control of the Nordic exchanges and technology operator OMX. The Dubai group bought most of Nasdaq's 31 percent stake in the LSE for £14.40 per share in cash. In return, it will take a 19.9 percent stake in the combined Nasdaq/OMX group and receive cash.3 This strategic alliance aims to forge the first global exchange platform, linking the ever elusive "pools of liquidity" in the United States, Europe, and the Middle East. In addition, within the United States, Nasdaq has agreed to acquire the Boston Stock Exchange ("BSE"), bolstering its clearing capabilities and position in the "dark pools" business as consolidation among exchanges continues. Included in the $61 million deal are the BSE's holding company, BSE Group, Boston Stock Exchange Clearing Corporation, and BSE's regulatory authority over the Boston Options Exchange. The ISD, effective since January 1996, was the legislative centerpiece of the single market program for the securities domain. According to the ISD, each recognized exchange is automatically accepted in other European Union ("EU") countries and offers remote access to intermediaries in other EU countries without imposing further regulatory burdens. In addition, ISD promoted remote membership and price disclosure. 4 The EU's Financial Services Action Plan ("FSAP") -a 3 Norma Cohen, LSE Faces Fresh Bidding War, FIN. TIMES, Sept. 20, 2007, available at http:/ /www.ft.com/cms/s/0/4c84fOee-674b-lldc-9443-0000779fd2ac .html (noting how Qatar Investment Authority and Borse Dubai now own nearly half of the London Stock Exchange). 4 See European Commission, FinancialSErvices:Implementing the Frameworkfor FinancialMarkets: Action Plan, COM (1999) 232 final (May 11, 1999) (detailing the Framework for Action program that the European Commission will pursue in its efforts to reach a "single financial market"). [Vol. 29:2 comprehensive 42-measure5 plan to harmonize member states rules with the aim of streamlining the integration of the EU markets -highlighted the need to update the ISD. Moreover, in 2000, the European Council set up the Committee of Wise Men on the Regulation of European Securities Markets to analyze and come up with recommendations on the law-making process concerning securities markets regulation in the EU, aiming both to expedite the process and increase its flexibility in order to incorporate market developments. In 2001, the final report by the Committee of Wise Men on the Regulation of European Securities Markets -commonly known as the Lamfalussy Report-was published, 6 and some of its recommendations were adopted by the European Council. 7 The ISD has been superseded by the MiFID, which will introduce a single market and regulatory regime for investment services in the EU. The objectives of MiFID are to complete the EU single market for investment services and to respond to changes in the securities markets by means of basic high-level provisions governing the organization and conduct of business requirements that should apply to financial services firms.8 5 These are mainly EU directives to be adopted prior to 2005. By the end of 2004, almost all of these measures had already been adopted. See EUROPEAN COMMISSION, WORKSHOP ON METHODOLOGY FOR THE FSAP EVALUATION: FSAP EVOLUTION CHART ( 2006 ), available at http://ec.europa.eu/intemal market/ finances/ docs/actionplan/ index/061003_measures.en.pdf (listing the FSAP measures planned and taken by the European Commission). 6 The final report was published on February 15, 2001. For a complete version of the report, see Lamfulussy Report, http://ec.europa.eu/intemal _market/securities/lamfalussy/index en.htm. 7 See Press Release, European Union, Results of the Council of Economics and Finance Ministers, 22 March 2001, Stockholm Securities Legislation (Mar. 23, 2001), (available at http://europa.eu/rapid/pressReleasesAction.do?reference =MEMO/01/105) (noting how the procedures discussed in the draft resolution would carry out ideas presented in the final report of the Committee of Wise Men on European Securities). 8 The key features of MiFID can be summarized as: ( 1 ) retaining the "passport" principle contained in the ISD broadening the scope of "core" investment services; ( 2 ) introducing the concept of "maximum harmonization," which focuses on "home" state supervision in lieu of "minimum harmonization/mutual recognition," which was the previous applicable criterion; (3) abandoning by certain EU member states of the so-called "concentration rule," which obliges firms to route all client orders through regulated exchanges; (4) including new pre- and post-trade transparency requirements for equity markets; (5) putting in place a more extensive transaction reporting requirement; and (6) most firms falling under the scope of the MiFID will have to comply with the Capital Requirements Directive. See, e.g., Parliament and Council Directive 2007] 459 European stock exchanges are turning into publicly-listed organizations following demutualization and aim at maximizing profits for their stockholders. Exchanges are moving from an era of monopolies to a new era marked by competition. According to Clayton, Jorgensen, and Kavajecz, sixty new financial exchanges were created between 1990 and 1999.9 Sofia Ramos identifies the likely contributing factors as "economic freedom in taxes, regulation and banking, and the existence of larger economies. In contrast, technology shocks that increase communication links reduce the likelihood of new exchanges being [physically] established." 10 The new wave of economic communications networks ("ECNs") "in the absence of regulatory barriers [renders] industry entry much easier than ever, since technological advances decrease the costs of setting up [a stock] exchange." 1 Several institutional changes were common in stock exchanges in Europe in the last two decades. These changes included: ( 1 ) several mergers and acquisitions, and ( 2 ) changes in the ownership structures, trading systems, and number of quoted companies, as well as the extension of trading hours. Stock exchanges have merged with derivative exchanges (for example, Euronext and LIFFE) and with settlement operators (for example, Deutsche Borse and Clearstream). Mergers that focus on combining different geographic markets aim at exploiting the economies of scale in trading. Mergers that have combined different activities aim at providing a more complete financial service to customers. One of the main exchange reforms was the computerization of trading. In 1977, the Toronto Stock Exchange "was the first exchange to computerize its trade." 12 Most exchanges currently operate electronic trading. The information system, order routing, queuing and execution systems are automated. The greatest advantage of electronic trading is its ability to promote cross [Vol. 29:2 border trading. The introduction of computerized systems is an important instrument for increasing competition among stock exchanges because it decreases transaction costs and thus increases liquidity. An analysis of international markets suggests that expected savings in total costs from automated execution technology are about 40 basis1 3 points.' 4 In addition, the number of listed companies has increased as an ever-larger number of companies seek access to pools of capital inside and outside their home country. Consequently, stock exchanges have increased trading hours to exploit trading in crossborder listed securities. Cross-border mergers trigger a series of different issues to be analyzed. From a transactional point of view, some of these aspects include the synergies that a merger creates, the complexities in achieving an optimal financial structure, and protection of minority shareholders. From a regulatory standpoint, there is an array of issues that should also be considered. Regulatory issues can be internal (compliance with rules of the stock exchange) or external (compliance with the regulatory requirements of the competent regulatory body or bodies). Regulatory issues can affect the parties involved in the stock exchange or the stock exchange itself. Moreover, these issues can be exteriorized at a national or international level. For example, the LSE is subject to the UK Financial Services Authority and EU directives, which include the MiFID and other directives such as the Market Abuse Directive, 5 the Prospectus Directive, 16 the Transparency Directive,' 7 and the Capital Adequacy Directive. 18 In 2007] 461 the same line of thinking, it can be argued that the NYSE abides by its own rules, the regulations imposed by the U.S. Securities and Exchange Commission ("SEC"), and state rules. Moreover, following these examples, it can be stated that both the LSE and the NYSE are subject to international soft law (e.g., International Organisation of Securities Commissions ("IOSCO")19) and external treaty obligations (e.g., the General Agreement on Tariffs and Trade ("GATT")20 and the General Agreement on Trade in Services ("GATS") 21). In addition, stock exchanges may be faced with the extraterritorial application of laws to their members as result of a dual listings or a private placement sell. First, we will provide an overview of general regulatory issues affecting financial entities. Consequently, and since one of the first steps to analyze from a regulatory perspective is the competition law 22 implications 23 - since if there is a breach of competition laws the whole merger might not take place -this will be the pillar of our analysis. We understand that observation of competition laws, from a broad perspective, can be understood as a regulatory issue. As far as the competition aspect is concerned, the focus will be on horizontal issues24 arising from such mergers, rather than any 19 IOSCO, together with the Basel Committee on Banking Supervision and the International Association of Insurance Supervisors, constitute the Joint Forum. Press Release, Int'l Org. of Sec. Comm'ns, Joint Forum: Amplified Mandate (June 14, 2002) (availableat http://www.iosco.org/news/pdf/IOSCONEWS3.pd. 20 GATT was part of the Bretton Wood's enginery with the aim of reducing barriers to international trade and foster-together with the other measures adopted at the time-recovery after World War II. ROSA MARIA LASTRA, LEGAL FOUNDATIONS OF INTERNATIONAL MONETARY STABILITY 346-47 ( 2006 ). 21 GATS resulted from the Uruguay Round negotiations and entered into force in 1995. It is a treaty of the WTO to extend the multilateral trading system of the GATT to services. General Agreement on Trade in Services, Apr. 15, 1994, Marrakesh Agreement Establishing the World Trade Organization, Annex 1B,THE LEGAL TExTS: THE RESULTS OF THE URUGUAY ROUND OF MULTILATERAL TRADE NEGOTIATIONS 283, 33 I.L.M. 1125, 1168 (1994). See generally, The General Agreement on Trade in Services (GATS): Objectives, Coverage and Disciplines, http://www.wto.org/english/tratop-e/ serv-e/ gatsqa-e.htm (lastvisited Nov. 28, 2007) (providing a background and overview of the GATS). 22 The term "competition law" also covers what is known as "antitrust law" in the United States. 23 From a competition standpoint, stock exchange mergers may have a severe impact on the competition among stock exchanges and thus lead to higher fees and lower quality of service. 24 Horizontal mergers are mergers between parties that operate in the same relevant market. Such mergers can increase the market power of the merging firms so that they could unilaterally impose a profitable post-merger price increase. Other firms in the market might raise their prices in response, also vertical issues25 arising from cross-border stock exchange mergers. 26 Within the specific regulatory aspects we will focus on the following competition law issues: " the provision of primary listing services to domestic companies; " the provision of secondary listing services and primary listing services to companies seeking listings outside their domestic market; " the provision of on-book equities trading services; * markets for bonds and derivatives trading; and " markets for information services as well as information technology services. This Article does not purport to substitute the competition/ regulation assessment of cross-border stock exchange mergers conducted by any competition/regulatory authority in any jurisdiction. It aims to provide a critical overview of some of the issues that may arise in cross-border stock exchange mergers. It does not attempt to provide a complete competition/regulation assessment of exchange mergers, since competition/regulation authorities can conduct such an assessment in their own capacity. In addition, this Article does not focus on any particular jurisdiction for assessing the likely anticompetitive impact of exchange mergers. Thus, if this Article alleges a likely adverse impact on competition, it does not refer to the legislation of any particular jurisdiction. This Article adopts a substantive rather than jurisdictional approach, and attempts to address the issues of unilaterally. Thus, rivalry might weaken. Moreover, a horizontal merger may increase the likelihood of (or stability and sustainability of) collusion, either tacit or explicit, between the remaining firms in the market. 25 Vertical mergers are mergers between parties that operate at different levels of an industry. Such mergers, though often pro-competitive, may in some circumstances reduce competitive constraints faced by the merged firm as a result of increased barriers to entry, raising rivals' costs, substantial market foreclosure or increased likelihood of collusion. This risk is, however, unlikely to arise except in the presence of existing market power or in markets where there is already significant vertical integration as well as vertical restraints. 26 No vertical issues in any relevant market will be addressed in this paper. For a report that addresses vertical issues to some extent in detail, see COMPETITION COMM'N, A REPORT ON THE PROPOSED ACQUISITION OF LONDON STOCK EXCHANGE PLC BY DEUTSCHE BORSE AG OR EURONEXT NV 6-7, 24-27, 66-74 (2005), availableat http://www.competition-commission.org.uk/rep-pub/reports/2005/ fulltext/504.pdf [hereinafter COMPETITION COMMISSION REPORT]. 2007] 463 competition that are likely to arise in jurisdictions as a result of cross-border exchange mergers. 27 SOME NOTES ON STOCK EXCHANGES AND THEIR REGULATION A capital market is a market within a financial system that provides a range of investment and financing tools. Capital markets can be considered as both primary capital markets (for an initial issuance of securities) and secondary capital markets (for the trading of securities previously issued). Moreover, capital markets operate with either equity securities (i.e., shares of a company, be it by means of an initial issuance or initial public offering ("IPO"), or by subsequent purchases and sales in the secondary market) or debt securities (e.g., bonds or other listed debt instruments). A transaction in a capital market can take place on the market itself (i.e., on a formal stock exchange), or off-the-market (i.e., off the stock exchange). If it occurs off-the-market, it is considered an over-the-counter ("OTC") transaction. A stock exchange is a formal (regulated) capital market where securities (equity and debt) are issued (primary market) and traded (secondary market). In academic economic literature, there are "at least three views of stock exchanges: the exchange as a market [or trading system], the exchange as a firm, and the exchange as a broker-dealer." 28 A stock exchange is a market or trading system that must: ( 1 ) provide trade execution facilities; ( 2 ) provide price information in the form of buy and sell quotations on a regular or continuous basis; (3) engage in price discovery through its trading procedures, rules, or mechanisms; (4) have either a formal market-maker structure or a consolidated limit order book, or be a single price auction and centralize trading for the purpose of trade execution; and (5) exhibit through system rules or design the likelihood of creating liquidity in the sense that there be entry of buy and sell quotations on a regular basis, such that both buyers and sellers have a reasonable expectation of regularly executing their orders at those quotes.29 In addition, a stock exchange can be seen as a firm that [Vol. 29:2 produces a composite good - the exchange of securities - which may be formed of different elements, such as price formation, counterpart research, insurance for a good clearing, and the standardization of the good exchanged. 30 According to this view, the owners of the exchange should satisfy all interested entities: intermediaries, issuers, and investors. Due to ownership structures, some of the customers may be the owners of the firms as well. Thus, the exchange's price for some of its products, e.g., trading fees, can influence the shareholders' value through the profitability of the exchange itself (and the impact of this profitability on the value of the firm) as well as through the price of the exchange's composite product that the consumers/shareholders are consuming. Private management and ownership may give greater efficiency to the exchange. Finally, according to the view of the exchange as a brokerdealer, the exchange is a kind of intermediary among intermediaries. The exchange gathers trading orders and supplies the way of executing them. An exchange facilitates information production and dissemination, as well as competition among traders. To facilitate this interaction, a stock exchange provides a marketplace where new shares are issued in companies seeking a listing and where those shares can be traded between investors. A stock exchange is responsible for setting criteria that companies must meet and continue to comply with to obtain and retain a listing. An exchange also has to ensure that the marketplace for securities which it operates works efficiently and is as transparent as possible. Finally, a stock exchange regulates direct access to the marketplace through membership admission and subsequent rules. As seen from previous paragraphs, another important aspect of stock exchanges is regulation. Regulation, as noted by Lastra, "refers to the establishment of rules, to the process of rulemaking, and includes legislative acts and statutory instruments issued by the competent authorities nationally and supranationally, international rules. .. , and rules issued by self-regulatory organizations and private bodies or 'clubs."' 31 Abrams and Taylor 30 Tommaso Padoa-Schioppa, La piazza finanziaria italiana: la sfida della privatizzazione [The Italiam Financial Market: The Challenge of Privatization], BOLLETrINO ECONOMIco, Feb. 1997, at 90, 90-91 (Italy). 31 LASTRA, supranote 20, at 84-85. 2007] 465 argue that in order to create an effective regulatory structure, the regulatory agency or agencies that have to perform supervisory functions must: ( 1 ) have clear objectives, ( 2 ) be independent and accountable, (3) have the necessary resources to perform the tasks commended, (4) have effective enforcement powers, (5) have comprehensive rules covering all aspects, (6) be cost efficient, and (7) have a structure that reflects the structure of the industry that it has to regulate. 32 In addition, specific regulation by itself would not be sufficient unless there are: ( 1 ) sound corporate governance practices; ( 2 ) preventive measures to avoid unfair barriers to entry, anticompetitive practices, and abuse of a market dominant position; (3) tax laws; (4) dispute resolution mechanisms; (5) an insolvency framework; and (6) a respect for the rule of law. 33 The interaction between regulation and enforcement is carried out by supervision, which in a broad sense includes the following areas:34 ( 1 ) licensing, ( 2 ) supervision stricto sensu, (3) sanctioning for non-compliance or breaching the applicable set of norms, and (4) crisis management. 35 Although there is no single correct approach to a regulatory issue, regulation should promote transparency of trading to deter manipulation and ensure the proper management of large exposures, default, and market disruption.36 The aim of stock exchange regulations and enforcement is to provide confidence to investors. If investors are confident with the market, they will be attracted to invest and the capital markets will grow. Capital markets play an important role in developed and developing countries. As a result of globalization and deregulation, we have been faced with an increased number of changes in the international financial markets. These changes have been exacerbated by the current business cycle and the need for large amounts of money to finance ongoing transactions. In addition, the technical evolution of communications has provided better and more reliable resources for the financial industry. All of these factors, together with the deregulation and harmonization achieved by means of "soft law", 37 have been determinant factors in the expansion of financial services. 38 One of the lessons the International Monetary Fund has drawn from the Asian crisis is the need for proper sequencing of capital account liberalization and financial sector development -including supervision and regulation, risk management, and transparency. 39 The Asian financial crisis triggered several proposals to reform the international financial system. These proposals, focusing on the prevention and avoidance of financial crises, have been denominated the new International Finance Architecture. 40 In the wake of the new International Finance Architecture, international organizations such as the IOSCO and the International Accounting Standards Committee ("IASC") are very active in the study, coordination, and promulgation of international standards in the area of financial market regulation and disclosure. Although their promulgations have the characteristic of being "soft law," they are being adopted and transformed in law in developing and 37 Soft law can be defined as guidelines that become generally accepted although they are neither enforceable nor legally binding. 38 It is worth stressing that most of these changes, starting in the late 1970s and early 1980s, led to a truly international financial market in the early 1990s that has moved extremely quickly as a result of the use of the Internet. 39 Horst Kohler, Managing Dir., Int'l Monetary Fund, A Public-Private Partnership for Financial Stability, Address at the Institute for International Finance, (May 31, 2001), availableat http://www.imf.org/external/np/speeches/ 2001/053101.htm. 40 For a description of the emergence of the International Financial Architecture, see Mario Giovanoli, A New Architecture for the Global Financial Market: Legal Aspects of InternationalFinancialStandard Setting, in INTERNATIONAL MONETARY LAW: ISSUES FOR THE NEW MILLENIUM 3 (Mario Giovanoli ed., 2000). For a detailed description of the proposals on the new International Financial Architecture, see BARRY EICHENGREEN, TOWARD A NEW INTERNATIONAL FINANCIAL ARCHITECTURE: A PRACTICAL POST-ASIA AGENDA (1999). 2007] CROSS-BORDER STOCK EXCHANGE MERGERS 467 developed countries at both the domestic and regional level. The most relevant documents on stock exchanges in the international arena are IOSCO's 2002 Objectives and Principles of Securities Regulation4l and the World Federation of Exchanges' Market Principles 2002.42 Also, in the area of payment and settlement, the Committee on Payment and Settlement Systems ("CPSS")- under the auspices of the Bank for International Settlements ("BIS") -has played an important role through the publication of the Core Principles for Systemically Important Payment Systems, 43 the CPSS/IOSCO Recommendations for Securities Settlement Systems, 44 and the CPSS/IOSCO Recommendations for Central Counterparties4.5 In addition to the international standards, specific market associations have played a key role by providing standardized contractual terms, e.g., the "Global Master Repurchase Agreement" 46 and the "Convertible Asset Swap Transaction" 47 provided by the International Capital Market Association ("ICMA") and the International Swaps and Derivatives Association ("ISDA"), respectively. The latter has played a very important role in the harmonization of contractual terms that has lead to practice harmonization since the drafters were the participants themselves- which implicitly guarantees their widespread adoption. 41 INT'L ORG. OF SEC. COMM'NS, supranote 33. 42 See WORLD FED'N OF ExCHS., MARKET PRINCIPLES 2002 ( 2002 ), available at http://www.world-exchanges.org/publications/WFE%20Market%20principles .pdf (suggesting minimum qualifications for securities markets to qualify as organized markets). 43 COMM. ON PAYMENT & SETTLEMENT SYS., CORE PRINCIPLES FOR SYSTEMICALLY IMPORTANT PAYMENT SYSTEMS (2001), available at http://www.bis.org/publ/ cpss43.pdf (providing core principles for payment systems for widespread implementation). 44 COMM. ON PAYMENT AND SETTLEMENT SYS. & TECHNICAL COMM. OF THE INT'L ORG. OF SEC. COMM'Ns, RECOMMENDATIONS FOR SECURITIES SETTLEMENT SYSTEMS (2001), available at http://www.bis.org/publ/cpss46.pdf (recommending minimum standards intended to cover all types of systems all over the world). 45 COMM. ON PAYMENT AND SETTLEMENT SYS. & TECHNICAL COMM. OF THE INT'L ORG. OF SEC. COMM'NS, RECOMMENDATIONS FOR CENTRAL COUNTERPARTIES ( 2004 ), available at http://www.bis.org/publ/cpss64.pdf (providing recommendations for the major types of relevant risks). 46 This is the agreement that governs sale and repurchase transactions. It was developed by ICMA with the Securities Industry and Financial Markets Association and includes legal opinions on its enforceability in different jurisdictions. 47 A template designed to use in inter-dealer convertible asset swap transactions. These initiatives and the referred documentation have helped EU regulators because the harmonization of different legal systems was eased by the integration of countries that followed the principles laid down by international organizations and associations. The FSAP and the Lamfalussy report, with its fourlevel procedure (framework principles, decisionmaking, national implementation and cooperation, and enforcement), also played a key role in the streamlining of financial regulation within the EU. These resulted, as previously mentioned, in the adoption of the ISD, which was superseded by the MiFID. Other directives are also relevant in the area of securities regulation, i.e., the Market Abuse Directive, the Prospectus Directive, the Transparency Directive, and the Capital Adequacy Directive. In addition, a communication on clearing and settlement was issued in April 200448 to improve clearing and settlement allowing market participants to operate effectively in an integrated EU financial market since-as noted by the European Commission-the situation as of today is complex and fragmented, imposing costs, risks and inefficiencies on investors, institutions and issuers. 49 Moreover, a draft proposal for a Directive of the European Parliament and of the Council on payment services in the internal market has been produced, and the final implementation of the Directive is expected for 2008.50 While the aims of the EU and NAFTA differ-since the latter only looks to create a free trade association-a positive movement towards the unification of the international financial markets has been accomplished among two of its three members (the United States and Canada). The multi-jurisdictional disclosure system ("MJDS") was "designed to facilitate securities offerings in multiple markets by subjecting the issuer to the regulations of only 2007] CROSS-BORDER STOCK EXCHANGE MERGERS 469 one [country]."51 Due to the similarities between U.S. and Canadian securities laws, the SEC authorized Canadian issuers who had complied with their local regulations to issue securities on the NYSE or Nasdaq. Unfortunately, the MJDS has not been extended to other countries since its adoption in 1991. Regrettably, since 1993, it is required to reconcile the financial statements with U.S. generally accepted accounting principles ("GAAP"). On the one hand, with all these changes, financial markets have gained in soundness. "IOSCO recognizes that sound domestic markets are necessary to the strength of a developed domestic economy and that domestic securities markets are increasingly being integrated into a global market."5 2 Therefore, a significant amount of credit has shifted from banks to capital markets in the form of securities. In today's current state securities are more liquid, more easily transferable, and have lower transaction costs. On the other hand, since stock exchanges have become publicly listed companies, like any other company, they need to produce dividends, i.e., gains for their shareholders. Moreover, as a result of globalization and in order to be able to compete with digital platforms and continue to generate revenues, they must have an international presence in key financial districts. This trend leads to their need to acquire other players or merge and/or establish links with their competitors or providers of similar services in markets where they are willing to gain access. However, all these changes and needs of the parties involved should not distract from the three interrelated and sometimes overlapping core objectives of securities regulation laid out by IOSCO: "( 1 ) the protection of investors; ( 2 ) ensuring that markets are fair, efficient, and transparent; and (3) the reduction of systemic risk." 53 It should also be borne in mind that stock exchanges, as financial institutions operating in financial markets, are prone to risks and exposure. These risks include: ( 1 ) credit risk, ( 2 ) market risk, (3) interest rate risk, (4) foreign exchange risk, (5) operational risk (which includes settlement risk), and (6) legal risk. Modern financial regulation is based on risk management5 4 51 HAL S. SCOTT & PHILIP A. WELLONS, INTERNATIONAL FINANCE 78 (8th ed. 2001). 52 INT'L ORG. OF SEC. COMM'NS, supra note 33, at 1. 53 Id. 54 See, e.g., Avinash Persaud, Liquidity Black Holes and Why Modern Financial Regulation in Developed Countries is Making Short-Term Capital Flows to Developing posing a challenge to financial firms to develop market-risk management techniques and to investors and regulators to observe and quantify risk. Particularly in the United Kingdom -as noted by Alexander-"the Financial Services and Markets Act 2000 ("FSMA") and its accompanying regulations create a regime founded on a risk-based approach to the regulation of all financial business."55 From the UK perspective, it can be argued that the risk-based approach can be divided into two approaches -a general risk approach and a specific risk-by-risk approach -which are identified under the Financial Services Authority's ("FSA") prudential sourcebook. Although regulation should take into account risks associated with stock exchanges, by no means should regulation deter reasonable risks of the industry. On the contrary, regulators should allow effective management of risks by establishing safety nets to monitor risk-taking and eventually by adopting the necessary measures (e.g., minimum capital requirements) to have a buffer in place that is required as a result of unforeseen circumstances affecting financial markets. Another issue to consider is how many supervisory bodies should be required for the surveillance of stock exchanges. In this matter, Lastra argues that there is no single answer due to the lack of empirical evidence, and that a state may have a single body, like in the United Kingdom (and Norway and Denmark and more recently in Germany and France), different bodies for different industries (i.e., banking, securities, insurance, etc. as in Italy or Spain) or multiple authorities within the industry, as in the United States.5 6 The case of the United States is very interesting since there are four sets of norms issued by different regulators: ( 1 ) federal laws passed by the U.S. Congress, ( 2 ) state laws passed by State legislatures, (3) regulations enacted by agencies (e.g., the U.S. Countries Even More Volatile (United Nations Univ. World Inst. for Dev. Econ. Research, Discussion Paper No. 2002/31, 2002) (proposing that the spread of market-sensitive risk management systems leads to a more fragile financial system). 55 Kern Alexander, CorporateGovernance and Banking Regulation, (Cambridge Endowment for Research in Fin., Research Programme in Int'l Fin. Regulation, Working Paper No. 17, 2004). 56 LASTRA, supra note 20, at 96 (arguing that there is no empirical evidence that any one model of organizing financial supervision is superior to any other). But see Rosa M. Lastra, The Governance Structure for Financial Regulation and Supervision in Europe, 10 COLUM. J. EUR. L. 49 ( 2004 ) (opposing the idea of a single EU financial regulatory body on the grounds of excessive concentration of power and concerns about accountability and transparency). 2007] CROSS-BORDER STOCK EXCHANGE MERGERS 471 Securities and Exchange Commission), and (4) regulation enacted by self-regulatory organizations ("SROs," e.g., Nasdaq, the NYSE, the Chicago Board Options Exchange, and the Chicago Mercantile Exchange). In addition, supervision can be performed by public, private, or both types of bodies. However, considering the sensitive nature of the matters involved in the event of a wrongdoing and the potential consequences for the whole economy (e.g., the Asian crisis) or the role to be performed by the government in the event of a crisis (e.g., the Drexel Burnham Lambert Group, Baring Bros., and Long-Term Capital Management Fund cases), a certain degree of public involvement is required. If a failure occurs, regulation should aim at reducing its impact by isolating the distressed entity and avoiding disruptions to the markets. Supervision requires initial scrutiny to grant a license and ongoing supervision to maintain the permission granted to operate. Ongoing supervision implies compliance with the required filings, meetings with officials from the supervisory body, inspections and additional disclosure that may derive from such inspections, and fulfilment of any resolution or sanction that might be imposed by the regulatory body. In the United Kingdom, sections 19 and 21 of the FSMA impose a general prohibition on, in the course of business, engaging in regulated activities and/or communicating an invitation or inducement to engage in investment activity unless authorized by the FSA. Under section 138 of the FSMA, the FSA has the capacity to enact rules, although specific reference is made to EEA 57 firms and the capacity of the firm's home state regulator. Those persons that have been authorized by the FSA will have to comply on an ongoing basis with the FSMA and the FSA's Handbook of Rules and Guidance.5 8 57 EEA stands for Economic European Area and includes the twenty-seven EU Member States plus Iceland, Lichtenstein, and Norway. 58 The FSA Handbook is a consolidated version of FSA's rule-making instruments. It is divided into seven "Blocks" and each Block is subdivided into modules. Block 1 deals with the requirements for all authorized persons and approved persons and contains general interpretative material. One of its modules is "FIT" (the Fit and Proper test for approved persons), which sets out the FSA's minimum standards for becoming and remaining an approved person. Block 2 sets out the prudential requirements that will affect firms. The Interim Prudential sourcebook ("IPRU") has five parts, each dealing with the prudential requirements for different sectors, i.e., ( 1 ) IPRU(BANK), the prudential and specific notification requirements for banks; ( 2 ) IPRU(BSOC), the prudential U. Pa. J. In t'l L. Carmichael and Pomerleano argue that in principle there are two fundamentally different models of regulatory structure (i.e., either based on institutions or on functions)59. However, lines have blurred and most regulatory structures in the world contain elements of both. The regulatory structure based on "institutions" fosters the establishment of different separate legal entities to regulate different aspects (e.g., prevention, functioning, crisis management, etc.) of different financial service sectors (i.e., banks, insurance, and securities). In some countries, two of the sectors are regulated together (e.g., securities and insurance, banking and securities, or and specific notification requirements for building societies and guidance on the exercise of certain of the FSA's functions under the Building Societies Act; (3) IPRU(FSOC), the prudential and specific notification requirements for friendly societies; (4) IPRU(INS), the prudential and specific notification requirements for insurers; and (5) IPRU(INV), the prudential and specific notification requirements for investment firms. Block 3 sets out most of the requirements that will affect firms day to day. Some of its modules deal with codes of conduct, training and competence, and money laundering. Block 4 consists of modules describing the operation of the FSA's authorization, supervisory and disciplinary functions. This Block is subdivided into four modules: ( 1 ) AUTH (Authorization); ( 2 ) SUP (Supervision); (3) ENF (Enforcement); and (4) DEC (Decision Making). Block 5 contains three modules dealing with the processes for handling complaints and compensation. Block 6 contains specialist modules, which show how the FSA Handbook of Rules and Guidance applies to certain sectors, such as credit unions. The most relevant of the modules included in this Block from the perspective of this paper is REC (Recognized Investment Exchanges and Recognized Clearing Houses), which provides guidance on how the FSA interprets the recognition requirements and other obligations on recognized bodies, such as Recognized Investment Exchanges and Recognized Clearing Houses, under the FSMA. Finally, Block 7 contains three modules which set out the requirements for issuers listed on, or seeking admission to, the official list of the UK Listing Authority ("UKLA"), rules that apply to a sponsor and a person applying for approval as a sponsor, along with the prospectus and disclosure document requirements. In addition, the FSA produces 14 sector-specific tailored handbooks of rules and guidance for small firms (e.g., asset managers, corporate finance advisory firms, general insurance brokers) which are about 90% smaller than the full FSA Handbook of Rules and Guidance and provide the most relevant information for each industry segment. To rely upon a tailored handbook, a firm needs to satisfy itself that it matches the attributes listed for that tailored handbook. Financial Services Authority, FSA Handbook, http://www.fsa.gov.uk/Pages/handbook/ (last visited Dec. 4, 2007). 59 JEFFREY CARMICHAEL & MICHAEL POMERLEANO, THE DEVELOPMENT AND REGULATION OF NON-BANK FINANCIAL INsTITUTIoNS 21-73 ( 2002 ). 2007] CROSS-BORDER STOCK EXCHANGE MERGERS 473 banking and insurance - but at least there are two different regulatory bodies).60 The weaknesses of this type of regulatory structure are, inter alia: ( 1 ) inefficient use of resources; ( 2 ) fragmented supervision; and, most importantly, (3) regulatory arbitrage by large financial conglomerates. The regulatory structure based on "functions" argues for the establishment of separate agencies to regulate different sources of market failure. Market failure is "a consumer oriented theory of regulation, which is rooted in the idea that market forces are the best means of ensuring that consumers' needs are met."61 The theory is based on the assumption that fierce competition among firms will generate benefits for consumers and that there is a disequilibrium that needs to be restored by means of regulation. The rationale behind this theory is that different "function" regulators will tackle the causes of the disequilibrium. The causes of the disequilibrium are competition, market conduct, asymmetric information, and systemic stability. Obviously, this theory has strengths (e.g., alignment of the regulation with the underlying source of the market problem) and weaknesses (e.g., overlap, conflict of agencies, and the resulting compliance inefficiency). A third possible alternative in financial regulation supervision is a unified regulatory body, as exists in the United Kingdom, Norway, Denmark, Germany, and France. It is said that a single regulator offers the best solution to efficiency, accountability, conflict problems, and effective regulation of conglomerates (reduction of regulatory arbitrage). However, the Centre for Policy Studies produced a report in 2005 stating that the FSA (the United Kingdom's single regulatory body) is "one of the most powerful, and one of the least accountable, institutions created in the UK since the war." 62 Sound and effective regulation is the key to the development and integration of stock exchanges in the global market. Soundness can be achieved by effective regulation. Effective regulation will provide confidence and attract investors. 60 See How COUNTRIES SUPERVISE THEIR BANKS, INSURERS AND SECURITIES MARKETS (Neil Courtis ed., 1999) (providing an overview of current financial regulation practices around the world). 61 Harry McVea, Financial Services Regulation Under the Financial Services Authority: A Reassertion of the Market Failure Thesis?, 64 Cambridge L.J. 413, 415 (2005). 62 CENTRE FOR POLICY STUDIES, THE LEVIATHAN IS STILL AT LARGE: AN OPEN LETTER TO MR JOHN TINER, CHIEF EXECUTIVE OF THE FSA 1 (2005). U. Pa. J. Int'I L. Confidence and more investors allow the stock exchanges to grow and interact. The interaction might lead to mergers but at the least will facilitate information-sharing, harmonization, and integration facilitating disclosure (pre-trade and post-trade)- one of the pillars in regulation since it promotes transparency, thus fostering investors' protection. Regarding the rationale behind a merger between cross-border stock exchanges, a report prepared by LECG argues that the integration of the French, Belgian, Dutch, and Portuguese stock exchanges "allowed Euronext to rationalize its operations and significantly reduce its operating costs." 6 3 This report analyzed the effects of the creation of Euronext. The process of integration "expanded the set of securities accessible to a Euronext member" and "increased the liquidity of the merging exchanges." 64 Therefore, it "reduced the implicit costs of trading." 65 "This increase in liquidity is reflected in lower bid-ask spreads, greater volume, and lower volatility .... [S]avings attained by Euronext through the integration of the trading platforms of its constituent exchanges... have been the result, in particular, of the elimination of duplications in IT activities and staff cost savings."66 The cost reductions achieved "were passed on to users via lower trading fees." 67 The econometric analysis they conducted showed "that the impact of integration on the average trading fee in Paris was a reduction of 15%. The average trading fee in Amsterdam fell by approximately 31% as a result of the creation of Euronext.... Integration of the Euronext markets has allowed all 63 MARCO PAGANO & A. JORGE PADILLA, EFFICIENCY GAINS FROM THE INTEGRATION OF EXcHANGES: LESSONS FROM THE EuRONExT "NATURAL EXPERIMENT" 4 (2005), available at http://www.competition-commission.org.uk/inquiries/ ref2005/lse/main_submission-received-euronext-nv-Iecg_2.pdf. 64 Id. at 49, 6. 65 Id. at 49. "Trading costs can be classified as direct (or explicit) and indirect (or implicit) trading costs. Direct costs include broker commissions and exchange and other fees, while indirect costs relate to effective spreads i.e., the difference between the price of a trade and the midpoint of the best-quoted bid and ask prices, just prior to the trade. The indirect component includes costs and risks associated with the immediacy or ability to trade without delay." OXERA CONSULTING, LTD., THE COST OF CAPITAL: AN INTERNATIONAL COMPARISON 28 ( 2006 ) [hereinafter OXERA]. 66 PAGANO & PADILLA, supranote 63, at 49-50. 67 Id. at 20. 2007] CROSS-BORDER STOCK EXCHANGE MERGERS 505 from the incumbent exchange to the new entrant in the market must be likely. The Competition Commission Report noted that "network effects make a liquidity shift hard to achieve" and that "in order for liquidity to shift, the incentives for trading firms have to be substantial."15 9 The Competition Commission went on to identify seven necessary conditions for switching to take place: (a) the new entrant must provide lower pricing and better quality of services; 160 (b) the new services must be able to be delivered by the entrant at a low cost; (c) the customers must be dissatisfied with the incumbent provider; (d) there must be a powerful, concentrated customer group, which has the ability to switch its trading business from the existing venue to the new provider; (e) this customer group must move in a coordinated fashion; (f) there must be no regulatory or political barriers in place fettering the entrant; and (g) there must be full access to existing clearing and settlement infrastructure. 161 The exchange brings together the two complementary types of "willingness" -the willingness of two parties to sell and buy at Price "p." The availability of both types of "willingness" is critical for the exchange to occur. 162 A positive size externality is that the increasing size of an exchange market increases the expected utility of all participants. Each investor benefits from the presence of other investors trading on the same platform. This is because the presence of larger numbers of traders tends to bring liquidity to the market. Thus, volume tends to concentrate on one trading platform. Traders are likely to send their orders simultaneously 159 COMPETITION COMMISSION REPORT, supranote 26, para. 5.59. 160 The Competition Commission was referring to pricing towards the exchange's customers (e.g., banks, etc.). 161 COMPETITION COMMISSION REPORT, supra note 26, para. 5.60. 162 See Nicholas Economides, The Economics of Networks, 14 INT'L J. INDUS. ORG. 673, 679 (1996) (explaining that an exchange of assets "brings together the 'willingness to sell at price p' (the 'offer') and 'willingness to buy at price p' (the 'counteroffer') and creates a composite good, the 'exchange transaction"'). since the likelihood of these orders being executed increases. For a credible threat of head-to-head competition, a competitor must offer a service with sufficient incentives to induce trading firms to overcome the disadvantages associated with switching costs. Clearing and settlement arrangements are also obstacles to competition for trading. Any entrant arguably requires access to the same or equivalent back office infrastructure as the incumbent. Other key issues include the quality of regulation and stock exchange rules, costs of trading and post-trading, technology improvements that benefit users, the costs of investment in IT systems, and technology and the extent to which markets offer access to a rich variety of fund managers and investors. The UK Competition Commission identified "two broad strategies that can be adopted to engage in head-to-head competition with an incumbent exchange, which could lead both [exchanges] to a shift in liquidity and/or induce the incumbent exchange to react by improving its offer." 163 A potential entrant may offer the same type of service as the incumbent, at a lower price. The Commission further stated that "in order for this strategy to succeed, the competitor needs to be able to afford to offer a sustainable incentive to switch liquidity in the form of a lower price. " 164 In addition, the competitor exchange may focus[] on product differentiation and [aim] to capture market share from the incumbent by introducing an offer which is seen as superior to the incumbent by a significant number of its users. In any attempt to shift liquidity there may be elements of both strategies as firms attempt to offer both a better and cheaper service. 165 The Competition Commission identified a number of exchanges that exercise a competitive constraint on the LSE, including Euronext, Deutsche BOrse, Nasdaq, NYSE Group, and OMX. 166 The Competition Commission argued that "the threat that [these exchanges] will expand their services and compete directly with LSE which disciplines LSE, forcing it to maintain higher service levels and lower fees than would otherwise be the case."167 163 COMPETITION COMMISSION REPORT, supra note 26, para. 5.38. 164 Id. 165 Id. 166 Id. paras. 5.64-71. 167 Id. para. 5.80. 2007] CROSS-BORDER STOCK EXCHANGE MERGERS 507 Given the number of credible potential competitors to the LSE, the Competition Commission concluded that the elimination of the horizontal constraint exercised by any one potential competitor is insufficient to give rise to a substantial lessening of competition within the market for on-book equities trading services in the United Kingdom. 68 In Europe, the examples of competition for trading in listed securities (such as, in 2004, the Dutch Trading Service) should be seen as credible threats -effective in gathering support among users and forcing incumbent exchanges to react-rather than as shifts in market shares. The degree of competition for trading is consequently low, and the threat of competitive entry (including from a non-European/U.S. exchange) is not likely to place a strong constraint on the major European exchanges. As mentioned above, it is unlikely that there is any significant actual competition in the market for the trading of cash equities between stock exchanges. As far as potential competition is concerned, network effects make a liquidity shift hard to achieve and, in this sense, represent a switching cost for customers. These costs imply that in order for liquidity to shift, the incentives for trading firms have to be substantial. Incentives may take the form of lower trading costs or incentive payments by the entrant exchange. However, for exactly the same reasons, the potential benefits for a competitor to induce such a shift are proportionately higher. Once gained, it will be hard for the incumbent exchange to win these customers back. Thus, the liquidity for a particular equity or group of equities will typically rest in one exchange. The shifting of that liquidity is crucially dependent on network effects. The stickiness of liquidity therefore represents the greatest barrier to entry in trading. Even if the argument of strong potential competition is valid, the potential entrants in the EU include, inter alia, LSE, Euronext, Deutsche Bbrse, Nasdaq, the NYSE Group, and OMX. Thus, any merger between two of these stock exchanges is unlikely to induce significant anticompetitive concerns in the EU, since there are adequate stock exchanges in the post-merger market to impose a credible threat of head-to-head competition on an incumbent. 168 COMPETITION COMMISSION REPORT, supra note 26, paras. 19-20. TRADING OF DERIVATIVES Derivatives are securities whose value is derived from some other time-varying, underlying instrument, usually the price of bonds, stocks, currencies, or commodities, as well as the movement of an index.169 Derivatives aim at providing insurance against market fluctuations. Trading in derivatives does not involve actual issuance of physical securities. 170 Examples of derivatives are futures and options. A futures contract is a standardized, transferable, exchange-traded contract that requires delivery of a commodity, bond, currency, or stock index, at a specified price, on a specified future date. While options entail a right, futures convey an obligation to buy. An option is a right to buy (call option) or sell (put option) an asset by a set date for a set price. 171 Exchanges may trade in equity derivatives, equity index derivatives, capital market or long-term interest rate derivatives, money market or short interest rate derivatives, commodity derivatives, and currency derivatives. An argument can be made that the above-mentioned types of derivatives constitute separate product markets. Each type of derivative has different characteristics and is used to achieve a different investment outcome. Derivatives exchanges may trade products in these areas. Liquidity for each product tends to be concentrated on one exchange. Exchanges tend not to compete directly with each other but may impose a competitive constraint through the threat of launching a trading service for a specific derivative contract in direct competition with an existing exchange. A significant number of derivatives trades are completed offexchange. OTC trading of derivatives is more intense than OTC trading of equity. 72 OTC provides a customized service, including less regulation than applicable to on-exchange trading, private 169 See SCOTr & WELLONS, supra note 51, at 939 (introducing the topic of derivatives including a discussion of futures and options); InvestorWords.com, Option Definition, http://www.investorwords.com/3477/options.html (last visited Dec. 2, 2007). 170 With regards to bonds, this Article will focus on the listing and trading of bonds rather than on post-trade services related to bonds. 171 ScoTr & WELLONS, supranote 51, at 939. 172 See COMPETITION COMMISSION REPORT, supra note 26, para. 2.4 (discussing equity trades that can occur off-book). CROSS-BORDER STOCK EXCHANGE MERGERS 509 negotiations, as well as discretion in the price. In particular, negotiations for on-exchange trading are transparent; whereas they are private in OTC trading, trading on-exchange is a regulated market where trades are standardized and are cleared and netted. OTC trading involves unregulated markets, where standardization as well as clearing and netting is limited. In addition, traders may have access to a wider pool of liquidity on exchange, including customers whose credit standing precludes them from using OTC trading. OTC and certain types of on-exchange derivatives tend to be complementary, since OTC occurs in complex transactions that cannot be completed on-exchange. For certain types of derivatives (e.g., when the underlying asset is equity), OTC plays a less significant role, compared to derivatives having other underlying assets. Criteria that investors take into account in choosing between on-exchange and OTC trading, include inter alia, the risk against which investors want to hedge, the availability of a suitable onexchange traded product, the size of the trade, the customization of the trade needed, the anonymity as well the desired impact on the price of the instrument, and the costs involved in the trade. Not all exchanges offer trading in all types of derivatives. If derivatives using different underlying assets are not substitutable from the customers' perspective due to the fact that they satisfy different customer needs, then each type of derivative may constitute a separate product market. In order for investors to substitute between two derivatives contracts having different underlying assets, these contracts must provide the same investment outcome that the investors want to achieve. For example, the financial market risk against which the investor aims at insuring, will determine the type of derivative he will use. Factors such as the duration of the derivative contracts, as well as the legal aspects also contribute to the substitutability of different types of derivatives contracts. However, if investors can achieve the same investment outcome by trading two different types of derivatives, or a bundle of different types of derivatives, then there is some substitutability between these types, and the product market may include more than one type of derivative. For example, customers may trade on derivatives that have equity of multinational companies as their underlying asset. This type of investment incorporates derivatives traded on more than one exchange as a means to hedge the market risks they face. Thus, these derivatives may be considered substitutes for one another. In order for all the types of derivatives, irrespective of the underlying asset, to constitute one market, exchanges must be able to easily switch between the provisions of trading of these types of derivatives. However, as is the case with equity trading, liquidity plays an important role on the exchange that will have the majority of trading of a particular type of derivative. As the Competition Commission Report stated, derivatives exchanges may trade products in "equity derivatives, equity index derivatives, capital market or long-term interest rate derivatives, money market or short interest rate derivatives, commodity derivatives, and currency derivatives." 173 In addition, "liquidity for each product tends to be concentrated on one exchange." 174 Another possible angle of the product frame of reference for derivatives is whether derivatives are substitutable according to the type of derivative (e.g., future vs. option) rather than according to the underlying asset. Investors are driven by the return on their investment. Thus, it seems likely that investors will use the underlying asset as the major choice factor. They are more likely to invest based on underlying assets familiar to them (e.g., stock index, interest rate) rather than on the type of contract. The choice of the type of contract (e.g., option, future) is likely to be made after the underlying asset has been chosen. Thus, it seems unlikely that the market will be defined according to the type of contract. 175 The OFT in the analysis of the Euronext NV/LIFFE Holdings plc1 76 merger argued that, in the short term, exchanges tend to specialize in certain product areas. Liquidity for each product tends to be concentrated on one exchange, and, therefore, exchanges do not always compete directly with each other. Although some customers substitute between products, each product has different characteristics and is traded in different situations for different investment aims. The OFT defined five separate derivative products: ( 1 ) single 173 COMPETITION COMMISSION REPORT, supra note 26, para. 4.60. 174 Id. 175 Notwithstanding, a complete competition analysis may illustrate different dynamics in competitive choices. 176 Office of Fair Trading, PROPOSED ACQUISITION BY EURONEXT NV OF LIFFE HOLDINGS PLC (2001), availableat http://www.oft.gov.uk/adviceandresources/ resourcejbase/Mergershome/mergersjfta/mergers fta advice/euronextnv. 2007] CROSS-BORDER STOCK EXCHANGE MERGERS 511 stock, ( 2 ) equity indices, (3) capital (medium- to long-term interest rates), (4) money (short-term interest rates), and (5) commodities. In addition, the OFT argued that OTC trading provides some degree of competitive constraint on exchanges, in terms of both prices and services. In the long term, the OFT argued that exchanges compete with each other in terms of innovation, rules, cost reductions, and other services. The relevant product market in the longer term was defined as the supply of derivative exchange services. However, in contrast to the OFT's position, the Competition Commission Report argued that derivatives exchanges "may trade products... in a selection of... areas." 177 Although no concrete conclusions can be made regarding the product and geographic market of derivatives trading, it seems likely that each type of derivative constitutes a separate product market with an international dimension. Thus, separate product markets may be identified for equity derivatives, equity index derivatives, long-term interest rate derivatives, short-term interest rate derivatives, commodity derivatives, and currency derivatives. There may be some scope for derivatives having similar underlying assets (e.g., long-term interest rate and short-term interest rate derivatives) to constitute one single market. However, this will depend on the actual substitutability between these two financial instruments in hedging against the same type of risk and achieving the same investment aims of investors. Such substitutability, without further investigation of customers and competitors of merging exchanges is ambiguous. "The four largest derivatives exchanges globally (by value of turnover) are the Chicago Mercantile Exchange; Euronext/Liffe; the Chicago Board of Trade; and Eurex."178 The following tables indicate the market share of the largest exchanges for stock options and stock futures as well as in short term interest rate options and futures.179 177 COMPETITION COMMISSION REPORT, supranote 26, para. 4.60. 178 Id. para. 5.11. 179 ANNUAL REPORT, supra note 99, at 104. The percentages have been calculated based on the total value of trading on all exchanges that a particular derivative is traded. Stock Futures ~U$ml2i0n05 Notional Value in US$ millions Stock Options Chicago Board Options Exchange Eurex Euronext.liffe Sao Paulo SE Australian SE Borsa Italiana Bourse de Montreal Philadelphia SE National Stock Exchange India Euronext.liffe Borsa Italiana BME Spanish Exchanges JSE Budapest SE Australian SE 2005 Notional Value in US$ millions 188,001,090 89,041,892 32,672,935 311,501 61% 29% 11% 0% Short term Interest Rate Options Chicago Mercantile Exchange Euronext.liffe Chicago Board of Trade Bourse de Montreal 180 Id. at 100. 181 Id. at 101. 182 Id. at 104. 2007] CROSS-BORDER STOCK EXCHANGE MERGERS 513 Short term Interest Rate Futures Chicago Mercantile Exchange Euronext.liffe Chicago Board of Trade SFE Corp. MexDer Tokyo Financial Exchange Bourse de Montreal (Notional Value: US$ millions-2005) 413,781,671 52% 281,718,123 35% 58,011,410 7% 15,666,591 2% 10,348,810 1% 10,200,010 1% 8,598,080 1% As these tables indicate, not all exchanges have a material overlap in these types of derivatives. Thus, not all likely mergers between these exchanges lead to post-merger entities having significant market shares. The same conclusion can be drawn for all types of derivatives. Competition for derivatives trading can take two forms, as can competition for equities trading: ( 1 ) direct (head-to-head) competition for the same derivatives contract, ( 2 ) threat of head-to-head competition. In regards to actual competition, not all exchanges are direct competitors for all types of derivatives. For example, there is unlikely to be any significant overlap in index derivatives since derivative products based on national indices are available on the exchanges where the listed equities are traded. As was the case for equities trading, and was outlined in the beginning of this Article, the possibility of potential competition will depend on the likelihood that liquidity will switch between exchanges. Unless there is an important technological development, a switch in liquidity is unlikely. Other aspects of competition include the provision of immediacy, price discovery, low price volatility, liquidity, transparency, transaction cost, reputation, quality, innovation, and rules. The provision of derivatives trading entails services such as pre-trade price discovery, trade matching, as well as post-trade management services. Elements of this service competition include trading hours, regional offices, and most importantly, the trading 183 Id. U. Pa. J.Int'l L. technology. Malkamaki argued that scale economies exist only in the very large exchanges but that there are significant scale economies with respect to the processing of trades. 184 This author also argued that "legislation and interim regulation of stock exchanges, as well as the microstructure of the trading system, are important elements of a liquid and efficient trading environment. It would .. .be optimal to centralize the trading systems so as to maximize scale economies arising in the processing of trading."8 5 Transaction costs indicate the explicit costs, which include broker commissions and exchange and other fees, effective spreads, as well as the implicit costs of the time required for its settlement. Because investors look for markets with smaller transaction costs, transaction costs are also associated with higher liquidity. Higher liquidity increases the utility of market participants. Transaction costs can have a negative impact on price discovery and volatility1 86 Price discovery is the process by which a market attempts to find transaction prices that bear the least risk. Investors prefer markets that have a greater flow of information. 8 7 Technological advancements such as computerized trading systems contribute to cross-border trading. Such advancements also contribute to more efficient trading by minimizing the delays and thus reducing the associated costs and contributing to beneficial spreads. Investors also look for operational efficiency and transparency. They are concerned about facilitation of their transactions (by matching buy and sell orders)lSS As the Competition Commission Report mentions, the extent to which off-book trading of derivatives, or the threat of head-to-head competition by a new derivatives exchange, represent a competitive constraint to an incumbent exchange, turns on... [many factors, including] 184 Markku Malkamki, Economies of Scale and Implicit Mergers in Stock Exchange Activities? 25 (Mar. 16, 2000) (unpublished manuscript, on file with the University of Pennsylvania Journal of International Law). 185 Id. at 25, 29. 186 See BENN STEIL ET AL., THE EUROPEAN EQUITY MARKETS: THE STATE OF THE UNION AND AN AGENDA FOR THE MILLENNIUM 65 (1996) (concluding that transaction costs affect price discovery and short-period price volatility). 187 Ramos, supranote 10, at 26. 188 See Ramos, supranote 10, at 26 (identifying factors that investors and firms look for in deciding whether to trade or list which exchanges can use to attract volume). 2007] CROSS-BORDER STOCK EXCHANGE MERGERS 515 the degree of substitutability between on- and off[exchange] trading of derivatives and the responsiveness of trading volumes to increases in exchange fees. 8 9 Off-exchange trading - although a separate market from onexchange trading-poses a significant competitive constraint on on-exchange trading. Thus, exchanges are likely to take the possibility of OTC trading into account in setting their pricing and innovation strategies. Regarding a shift in liquidity due to an increase in the trading fees, as the Competition Commission Report notes, network effects make a liquidity shift hard to achieve, and in this sense represent a switching cost for customers. These costs imply that in order for liquidity to shift, the incentives for trading firms have to be substantial. These incentives may take the form of lower trading costs or incentive payments by the entrant exchange. However, for exactly the same reasons, the potential benefits for a competitor to induce such a shift are proportionately higher. Once gained, it will be hard for the incumbent exchange to win these customers back. 90 As mentioned above in the analysis of the equities trading market, an important competition factor is technological advancement. Trading fees do not play an important role in trading. Technological advancements contribute to cross-border trading as well as to more efficient trading by minimizing the delays and thus reducing the associated costs and contributing to beneficial spreads. The intensifying competition in the market is due to commitments by regulators of promoting competition, as well as due to advancements in technology. Finally, pressure from customers has also contributed to intensifying competition. As the above analysis has illustrated, exchanges face strong competitive constraints from OTC trading. In addition, the driving force of competition seems to be technological advancement. 191 189 COMPETITION COMMISSION REPORT, supra note 26, para. 4.61. 190 Id. para. 5.59. 191Stock exchange mergers may have both positive and negative effects on technological advancement. A positive impact involves economies of scale in innovation, whereas the negative impact may include less incentive to innovate, as well as limited ability for competitors to enter the market. An additional essential factor for competition is the post-trade services. Without a unified postImproved technology can lead to efficiency in matching and executing orders, to lower trading costs, as well as to an increase in the volume of trading. Competition seems to be strong, and a merger between two of the exchanges may lead to a dampening of this competition in technological advancement. However, not all exchanges are direct competitors for all types of derivatives. Thus, the likely overlaps are likely to be fewer than the types of derivatives available. 192 As regards the threat of head-to-head competition, a significant number of exchanges exist and may pose competitive constraints on each other (e.g., Chicago Mercantile Exchange, Euronext/Liffe, the Chicago Board of Trade, and Eurex). Turning to the framework of competition assessment, taking into account the fact that the majority of derivatives trading occur OTC, as well as the fact that competition takes place in the form of competition for technological advancement and the existence of a significant number of major exchanges, a merger between two exchanges may not create severe competition concerns. However, as Tables 7, 8, 9, and 10 indicate, on some types of derivatives a potential combination of some of exchanges may lead to a significant market share of the merged entity. 193 In such hypothetical merger situations, a merger between two leading exchanges in these markets may lead to an adverse impact on competition. This outcome is based on an assessment of the publicly known facts. An investigation by a competition authority may reveal an adverse impact on competition in derivatives trading resulting from a merger between exchanges. Any potential competition concerns may arise as a result of a worsening of the derivative exchange services incorporating innovation, rules, cost reductions and other services. trade system, users need to net positions against each other, incurring higher costs. However, as mentioned in the introduction of this paper, post-trade services are outside the scope of this paper. Thus, no further analysis will be provided. See id. para. 5.136 (providing a detailed account of the likely impact of mergers on post-trade services). 192 Assuming that each type of derivative constitutes one separate product market, this is a reasonable assumption to make. 193 An indicating factor of likely concern may be the market share of the postmerger entity. However, market shares as well as concentration ratios can only provide an initial indication as to the effects of the merger and are not conclusive. In this particular case, market shares may not be a good direct indicator of the market power of exchanges because they will, to a great extent, simply reflect the relative size of the capital markets associated with each exchange. 2007] CROSS-BORDER STOCK EXCHANGE MERGERS Bonds are issued by credit institutions, governments, or companies and serve as long-term credit financing for the issuer. Bonds can be classified in different forms, namely, interest rate bonds (floating rate bonds, fixed rate bonds, zero coupon bonds), government issued bonds (government/ federal bonds, Eurobonds, emerging market bonds), and private issued bonds (corporate bonds, collateralised mortgage bonds, Tier 1 bonds). Other types of bonds include foreign currency bonds and convertible bonds. With regards to bonds, this Article will focus on the listing and trading of bonds rather than on post-trade services related to bonds. Bond issuers are likely to list the bonds on the exchange having a significant pool of liquidity. In addition, they are likely to choose exchanges where other bond issuers having similar characteristics to them (e.g., same nationality) have chosen as their listing venue. Government bonds (public sector bonds) are more likely to be listed on national exchanges than foreign exchanges (except the case of developing countries that usually issue sovereign bonds abroad), whereas corporate bonds are likely to be listed both on the domestic as well as on foreign exchanges. It should be noted that once the bond is listed, trading of the bond occurs on a multitude of on-exchange as well as off-exchange platforms, irrespective of the listing exchange. The relevant product frame of reference may include both government and corporate bonds. Further investigation will be needed by competition authorities, with respect to the substitutability between these two types of bonds, in order to determine whether the market for the listing of bonds should include both government and corporate bonds. This Article attempts to address the issues that are likely to determine the product and geographic frame of reference. In Europe, the bond market is dominated by government bonds and bonds issued by financial intermediaries. Researchers at The Center for Economic Policy Research write, "In the United States, the proportion of bonds issued by the non-financial corporate sector is much larger. In addition, municipal bonds and agency bonds are major components of this market." 94 The 194 BRUNO BIAIS, ET AL., EUROPEAN CORPORATE BOND MARKETS: TRANSPARENCY, LIQUIDrrY, EFFICIENCY 1 (Ctr. for Econ. Policy Research ed., Corp. of London 2006) availableat http://www.cepr.org/PRESS/TT-governmentFULL.pdf. following table indicates the top exchanges according to the value of bond listings. Foreign 6,470,606 0 0 898,561 537,312 62,951 252 n/a 174,795 195 ANNUAL REPORT, supra note 99, at 88. 2007] CROSS-BORDER STOCK EXCHANGE MERGERS As Table 11 illustrates, exchanges receive listings of both domestic public and private sector bonds, as well as of foreign bonds. However, not all exchanges receive listings of foreign bonds. From the top 23 exchanges receiving bonds listing, only in five of them do foreign bonds listings represent more than 25% of the total value of bonds listed. The majority of the value of listed bonds represents domestic bonds in all cases except for the Luxembourg Stock Exchange. This table indicates that domestic public sector bond issuers tend to list on the domestic exchange, which may not be the case for domestic private bond issuers. 196 Thus, a degree of home bias is indicated for domestic public sector bond issuers. Thus, the geographic frame of reference is likely to be national. As regards the listing of private sector bonds, in the majority of these exchanges, the value of the public sector-listed bonds is higher than the value of private sector listed bonds. This indicates a tendency of private sector bonds being listed outside the domestic market. Since not all exchanges receive listings of foreign bonds, the geographic frame of reference for the listing of private sector bonds may include certain exchanges (e.g., Luxembourg Stock Exchange, LSE, Borsa Italiana, Swiss Stock Exchange). The above analysis indicates that the geographic frame of reference is likely to be regional/international. As the European Central Bank states, "[t]he growing importance of the euro as an international investment currency has made the market for euro-denominated issues more attractive for both investors and issuers." 197 Thus, a regional "Euro-zone" geographic frame of reference may be relevant for both public and private sector bonds of "Euro-zone" countries. Assuming that the listing of private sector bonds constitutes a separate market from the listing of public domestic bonds, further investigation is needed to confirm whether national exchanges can constitute the geographic frame of reference for the listing of government bonds. Investigation is also needed to determine 196 This is true assuming that the total value of domestic public sector bonds is not much higher than the figures of this table. In addition, the assumption is made that the total value of domestic private sector bonds is higher than the values indicated in the table. If any of these assumptions is not satisfied, then the product frame of reference may not be the one alleged above. 197 EUROPEAN CENTRAL BANK, THE EURO BOND MARKET STUDY 5 ( 2004 ), available at http://www.ecb.int/pub/pdf/other/eurobondmarketstudy2004en. pdf. whether the geographic frame of reference for the listing of private sector bonds can include regional and/or transnational exchanges. A more complete analysis of the degree to which domestic public sector bonds are listed on the domestic exchange as well as of the degree of "non-domestic"' listings of private sector bonds will shed light on the relevant geographic frames of reference. If the frame of reference can be defined in these terms, then any cross-border exchange merger is unlikely to have any impact on competition, since domestic exchanges are complementary as far as the listing of public sector bonds is concerned. Regarding the listing of corporate bonds, under a regional (or even international) geographic frame of reference, certain permutations of mergers between two or more of the above exchanges are likely to have a significant anticompetitive impact. If the product frame of -reference includes both public and private sector bonds, then the geographic market is likely to be regional/ international, since private sector bonds are more likely to list outside the national market. As mentioned above, a regional geographic frame of reference may include, inter alia, the Luxembourg Stock Exchange, LSE, Borsa Italiana, and the Swiss Stock Exchange. As mentioned above, trading of bonds occurs on a multitude of on-exchange as well as off-exchange platforms, irrespective of the listing exchange. 198 Although the Luxembourg Stock Exchange has the largest value of bonds listed, it is not in the top 19 trading exchanges with regards to bond trading, as the following table indicates. 198 A further segmentation may be made into trading by institutional investors (wholesale trading) and trading by private investors (retail level). This segmentation is not addressed in this Article further, but may constitute the subject of an investigation by competition authorities. 2007] CROSS-BORDER STOCK EXCHANGE MERGERS TABLE 12: TRADING OF BONDS IN US$ MILLIONS, 2005199 Foreign Thus, the geographic frame of reference for bond trading is not confined to national boundaries. Bonds are likely to be traded on exchanges that can provide sufficient liquidity. As the ECB Report stated, the key element behind the development of the European 199 ANNUAL REPORT, supra note 99, at 92. bond market was the impetus for a better integrated and more liquid market. 200 "Liquid bond markets bring transaction costs down for investors, who therefore achieve greater gains .. .and minimize the cost of funds to firms." 201 Competition is a key driver of liquidity, so public policy should focus on openness and competition. In addition, trading of a particular bond is likely to take place on exchanges where other bonds having similar characteristics (e.g., same nationality) are traded. One particular characteristic may be the currency; thus, a possible geographic frame of reference may be regional, comprising bonds traded in the same currency (e.g., Eurozone).2 2 Improved access to financial markets within the EU allows investors to diversify their portfolios and invest more easily in foreign markets. Thus, investors are likely to trade on exchanges other than their domestic one. Thus, the geographic reference is likely to be at least regional (or even international). Assuming the frame of reference is defined as the trading of bonds at a regional geographic reference, any merger between stock exchanges from different regions is unlikely to lead to competition concerns, since there will be no overlap between the activities of exchanges of different regions. If the geographic reference is international, then certain permutations of mergers between two or more of the above exchanges are likely to have a significant anticompetitive impact. An important factor in the assessment of the impact of competition on the market for bond trading is the extent of bond trading that occurs OTC. The ECB Report emphasizes the importance of OTC trading in bonds. It argues that "[t]he secondary market activity traditionally takes place in the wholesale [OTC] market." 203 "The euro-denominated bond secondary market has been characterized by the growing use of multilateral electronic trading systems .... [Such systems have] lower costs, higher liquidity, transparency and easier cross-border trading. This trend was clearly visible in the more homogenous and liquid 200 EUROPEAN CENTRAL BANK, supra note 197, at 5. 201 BIAIS, ET AL., supra note 194, at 1. 202 The ECB Report stated that "since many investors prefer assets denominated in local currency, the introduction of the euro has reduced the home bias of euro area investors and further promoted the diversification of investments within the euro area." EUROPEAN CENTRAL BANK, supranote 197, at 5. 203 EUROPEAN CENTRAL BANK, supranote 197, at 21. 2007] CROSS-BORDER STOCK EXCHANGE MERGERS government bond sector." 20 4 The European Central Bank also states that due to "the large size of the OTC bond market, competition among trading markets caused the proliferation of new trading platforms [including] regulated markets and alternative trading systems ("ATSs")." 2 5 A report by the Centre for Economic Policy Research ("CEPR") also states that the corporate bonds are mostly traded OTC.206 Thus, OTC poses a significant competitive constraint on the provision of bond trading services by exchanges. However, it is unlikely that OTC and onexchange trading will constitute one single market, since these two types of trading satisfy different needs. In assessing the impact of a merger between two of the above exchanges on competition, it should be noted that OTC trading is a very important factor in the trading of bonds. The mere impact of OTC bonds trading mitigates the severity of anticompetitive effects on the market for the trading of bonds, since it is likely to exert significant competitive constraints on on-exchange trading. In some jurisdictions, the impact of a merger on the bond trading market is unlikely to be important due to the fact that the vast majority of bond trading occurs OTC. As the Competition Commission argued, nearly 100 percent of bond trading in the United Kingdom takes place off-book.207 In such cases, any merger between cross-border exchanges is unlikely to induce any materially adverse impact on competition, due to the lack of onexchange bond trading. MARKET INFORMATION SERVICES AND INFORMATION TECHNOLOGY SERVICES 204 Id. at 30-31. 205 Id. at 31. 206 BIAIS, ET AL., supra note 194, at 2. 207 COMPETITION COMMISSION REPORT, supra note 26, para. 2.4. 208 Id. para. 4.74. U. Pa. J. In t'l L. According to the Competition Commission Report, "[a]n exchange is the sole provider of its proprietary market information, [and such] information is not necessarily substitutable for market information from another exchange." 2 9 It is likely that nonproprietary market data is part of a wider financial services data market.210 In such a wide market, there are a multitude of providers of such information. Stock exchanges and financial services companies, such as Reuters and Bloomberg, provide nonproprietary information. Thus, the geographic frame of reference is likely to be worldwide. With respect to proprietary information, there is no overlap amongst the different exchanges. A merger between stock exchanges is unlikely to lead to any competition concerns due to the lack of overlap. As regards non-proprietary information, due to the large number of providers of such information, a merger between stock exchanges is unlikely to lead to any competition concerns.211 Turning to the market for information technology services, such services relate to the development and provision of software for electronic trading as well as for clearing and settlement. OMX212 states that it is the world's largest provider of technology solutions for securities trading, with a customer base that currently encompasses more than 60 exchanges, clearing organizations, and central securities depositories in more than 50 countries. 213 In order to strengthen its offering to marketplaces, OMX acquired Computershare's Markets Technology operations. According to OMX, the combination of OMX and Computershare's product portfolios will have the effect of substantially expanding their offering to global exchanges. 214 Accenture, which is a global management consulting, 209 Id. para. 4.75. 210 Id. para. 4.76. 211 That will also depend on the extent to which an exchange holds shares on a provider of non-proprietary information. 212 OaX owns exchanges in the Nordic and Baltic region, and develops and provides technology and services to companies in the securities industry around the globe. OMX Corporate, http://www.omxgroup.com/omxcorp/, (last visited Dec. 9, 2007). 213 OMX ANNUAL REPORT 2005, at 21 (OMX Board of Directors, eds., 2005), available at http://www.omxgroup.com/digitalAssets/937_OMX_2005_ENG _web.pdf. 214 Id. 2007] CROSS-BORDER STOCK EXCHANGE MERGERS outsourcing, and technology services company, established itself as a leader in the global marketplace. It assists capital markets in offloading non-distinctive corporate and securities operations. Accenture transformed how trading operations are executed and how information is disseminated among investors. Some of its customers include the LSE, Hong Kong Stock Exchange, Johannesburg Stock Exchange, as well as DTCC, which is the world's largest securities clearing, settlement, and servicing organization. 215 Tata Consultancy Services Limited ("TCS") is one of the world's leading information technology consulting, services, and business process outsourcing organization. TCS has developed IT solutions for over 500 customers all over the world. One of its clients is the Bombay Stock Exchange. 216 Thus, from the examples included above, it can be concluded that the relevant geographic frame of reference is likely to be global. Several companies provide exchange-related IT services. As was the case for non-proprietary information, due to the existence of a multitude of companies providing IT services to exchanges, on a global scale, any competition concerns as a result of a merger between exchanges are unlikely to occur. However, if the merger involves exchanges which hold shares in providers of exchange-related IT services (e.g., OMX), then competition concerns may arise. Such a conclusion needs to be based on a careful assessment of the impact of such a merger. 10. CONCLUSION It would be useful to present the benefits of financial integration. London Economics prepared a report for the European Commission on the integration of EU financial markets. In that report, it argued that: Through a more open and effective European financial market a number of benefits are expected for both investors and the corporate sector. Investors will benefit from higher risk-adjusted returns on savings, through enhanced 215 See Accenture, http://www.accenture.com/Global/Services/Client _Successes/By-Industry/Financial-Services/CapitalMarkets, (last visited Dec. 2, 2007) (describing scope of services and successes of clients). 216 About TCS, http://www.tcs.com/AboutUs/AboutUs.html, (last visited Dec. 9, 2007). U. Pa.J. In t'l L. In particular, regarding equity markets, trading costs could fall sharply as a result of full European financial market integration. As regards corporate bond markets, financial market integration will result in a deeper and more liquid market and should lead to further reductions in the credit spread (or risk spread relative to a comparable risk-free security) required by investors. Some permutations of mergers may induce competitive harm and thus lead to a post-merger market characterized by a lower degree of competition. This would lower the degree of innovation as well as the improvement of exchange services. As the London Economics Report states, "competition in the financial intermediation sector will offer corporations a wider range of financial products at attractive prices." 218 It should be emphasized that sound and effective regulation is the key to the development and integration of stock exchanges in the global market. Effective regulation will provide confidence and attract investors, allowing stock exchanges to grow and interact. However, there is no single regulation structure that will be suitable to all countries. 219 Each country has to develop the regulatory structure that best suits its need, taking into account historical, cultural, political, social, and economic issues. The burden falls on competition/regulation authorities to ensure that effective and sufficient competition remains after any consolidation in the stock exchange industry. 217 LONDON ECONOMICS, QUANTIFICATION OF THE MACRO-ECONOMIC IMPACT OF INTEGRATION OF EU FINANCIAL MARKETS i ( 2002 ) available at http://ec.europa.eu/ internalmarket/securities/ docs/ studies/ summary-londonecon-en.pdf. 218 Id. 219 Abrams & Taylor, supra note 32, at 27. 2006 /48, Relating to the Taking Up and Pursuit of the Business of Credit Institutions , Annex 1, 2006 O.J. (L 177) 1 , 57 [hereinafter Capital Requirements Directive] (indicating that safe custody services are subject to mutual recognition). 9 Matthew J . Clayton , et al., On the Formation and Structure of International Exchanges 1 (Tinbergen Inst ., Discussion Paper No. TI 99-079/2 , 1999 ). 10 See Sofia B. Ramos, Competition Between Stock Exchanges: A Survey 6 ( Int'l Ctr. for Fin. Asset Mgmt . & Eng' g, Research Paper No. 77 , 2003 ), available at http://www.swissfinanceinstitute.ch/rp77.pdf (discussing the development of competition in the context of stock exchanges) . 11 Id. 12 Id. at 8 . 13 One hundred basis points is equivalent to 1 percent. 14 Ian Domowitz , Liquidity, Transaction Costs , and Rein termediation in Electronic Markets , 22 J. FIN . SERVICES RES . 141 ( 2002 ). 15 Parliament and Council Directive 2003 /6, On Insider Dealing and Market Manipulation (Market Abuse) , 2003 O.J. (L 96) 16 [hereinafter Market Abuse Directive]. 16 Parliament and Council Directive 2003 /71, On the Prospectus to be Published When Securities are Offered to the Public or Admitted to Trading, 2003 O.J. (L 345) 64 [hereinafter Prospectus Directive]. 17 Parliament and Council Directive 2004 /109, On the Harmonisation of Securities are Admitting to Trading on a Regulated Market, 2004 O.J. (L 390) 38 [hereinafter Transparency Directive]. 18 Parliament and Council Directive 2006 /49, On the Capital Adequacy of Investment Firms and Credit Institutions , 2006 O.J. (L 177) 201 [hereinafter Capital 2. 27 In this Article, stock exchange mergers will refer to cross-border stock exchange mergers. 28 Carmine Di Noia, The Stock-Exchange Industry: Network Effects , Implicit Mergers , and CorporateGovernance, 33 QUADERNI DI FINANZA 3 , 17 ( 1999 ) (Italy) . 29 Id . 32 Richard K Abrams & Michael W. Taylor , Issues in the Unificationof Financial Sector Supervision 5 -9 ( Int'l Monetary Fund , Working Paper No. WP/00/213, 2000 ). 33 INT'L ORG . OF SEC. COMM'NS, OBJECTIVES AND PRINCIPLES OF SECURITIES REGULATION, Annexure 3 ( 2002 ). 34 LASTRA, supranote 20 , at 85 . 35 Crisis management in financial institutions can become something of Versus Securities Market Regulation 26-27 (Wharton Fin. Insts . Ctr, Working Paper No. 01 - 29 , 2001 ). 36 See INT'L ORG . OF SEC. COMM'NS, supra note 33 (proposing 30 principles of securities regulation) . 48 Communication from the Commission to the Council and the European ( 2004 ) 312 final (Apr . 28, 2004 ). 49 See The E.U. Single Market , Financial Markets Infrastructure, Clearing and indexen. htm (last visited Nov. 2 , 2007 ) (providing access to documents and settlement) . 50 Proposal for a Directive of the European Parliament and of the Council on Payment Services in the Internal Market and Amending Directives 97 /7/EC, 2000 /12/EC and 2002 /65/EC,COM ( 2005 ) 603 final ( Dec. 1 , 2005 ).


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Ioannis Kokkoris, Rodrigo Olivares-Caminal. Some Issues on Cross-Border Stock Exchange Mergers, University of Pennsylvania Journal of International Law, 2007,