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Boiled frog syndrome

Students of management gurus will probably know the analogy often used to depict how change can catch you unawares. It involves the boiling frog, and it goes something like this: if you put a frog in a saucepan of cold water, then slowly apply heat underneath it, the frog won’t notice the rise in temperature until it’s too late to do anything about it.
The European securities market currently has quite a few gently simmering frogs in its ranks, and the heat is being turned up every day. Last month saw the launch of two new pan-European exchanges, Jiway and Tradepoint, both of which have been partially motivated by a sense of frustration over the lack of progress by national stock exchanges towards a common trading platform. Whilst Jiway is concentrating on the retail sector, Tradepoint is looking to expand its franchise beyond the UK.
Meanwhile, the alliance of European stock exchanges continues to drag its feet. Some of its members have clearly tired of waiting for action. Deutsche Börse (DB), for example, is making waves with its aggressive expansion programme, which includes the sale of its electronic trading platform, Xetra, to other exchanges and its ownership of 50% of Clearstream, the international securities depository, and Eurex, the world’s largest futures exchange. It recently announced the launch of a new exchange, NEWEX, for central and eastern European securities, in a joint venture with the Wiener Börse. Settlement will naturally be handled by Clearstream. DB also has plans to change its ownership structure and, ultimately, its name.
But DB is the exception rather than the rule. Too many exchanges have failed to understand the dynamics of the new, online world of securities trading and investment, where liquidity pools can be accessed by smart electronic crossing networks (ECNs). The primacy of national exchanges is being challenged by the power of technology, and it is fairly obvious which will win.
The urgent need for these electronic solutions is largely motivated by a
predicted explosion in retail share trading volumes, which is fast turning into one of Europe’s greatest challenges. Jiway, the exchange being established by Morgan Stanley Dean Witter and the OM Group, expects online trading volumes to triple by 2003. There has been a surge in global demand for securities. As a result, the number of trades is growing at an exponential rate, from 450m in 1996, through to 650m in 1997, up to 830m in 1998 – a near doubling of volume in three years. This is expected to double again by 2002, with half coming from the retail side.
According to figures produced by Forrester Research, changing investment habits will drive Europe’s online brokerage accounts to 14m by 2004, up from 1.3m accounts today. Forrester says that robust services and cheap trades make Germany the largest market for online trading in Europe, with 550,000 accounts today. By 2004, this number will grow to 3.5m. The best online financial experience can be found in the Nordic countries, where 30% of consumers own stock and 10% already trade online. Despite a combined population of only 21m, the number of online accounts in Denmark, Finland, Norway, and Sweden will reach 3.1m by 2004. Forrester expects that it will take four years for the UK and France to begin narrowing the gap with Germany.
With such huge volumes to contend with, market players are looking for integrated packages that combine order management and routing, trading, execution, clearing and settlement. They do not want fragmented services spread across different providers, and they cannot afford any weak links in the chain. Smart custodians, like State Street, The Bank of New York and Brown Brothers Harriman, have spotted this requirement and have developed vertically-integrated product lines that enable to whole trade process to be ‘internalised’.
That principle is also behind the Jiway and Tradepoint offerings, and it clearly points the way ahead for the securities markets. But many European exchanges and depositories have yet to catch on, and risk being left behind in the stampede to capture all this cross-border activity. Whilst the DB model isn’t yet complete, it already demonstrates what an exchange needs to be doing in order to survive and prosper. London, of course, has most to lose from this, but it seems almost aloof from developments, as if it still believes it has a divine right to international business. The rapid demise of LIFFE is ample proof of the foolishness of that attitude. If they cannot adjust to the new world order, the London Stock Exchange and CREST are in danger of ending up like boiling frogs.

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