Merger mania is in the air. So far, aside from generalities, little has been said about what benefits a merger between the TSX and the LSE would bring to shareholders and users. Since shares have to be listed on a public exchange and Canada has only one, the TSE has some aspect of a public good. Moreover, whereas the merger of the various European stock exchanges in the beginning of last decade made a lot of sense, the new cross border transactions are a different kind of animal. One has to wonder what benefits are derived from the merger of cross border stock markets. There have been a number of studies, although the “merger mania” only began 12 years ago. So far the data is sketchy, and most analysis seems to indicate that, at worse, users are no worse off.
A few years ago the Montreal and Toronto stock exchanges merged. This was probably a good merger because Montreal’s position as the sole market for derivatives was being challenged by Toronto (following the ending of a 10 year non-compete agreement). A costly fight between markets was avoided and market stability remained. However, users saw no tangible benefits in the form of lower commissions or maybe lower posted collateral. The only benefits appears to be intangible: a steady market maintained liquidity, and in the business of derivatives liquidity is all important.
The question then becomes what is the reason for merger, and what are the reasons for the various levels of governments to support or deny the merger (especially cross border in nature)?
For the users there are three core aspects to the stock market: liquidity, pricing and price discovery. Over the past decade the rise of “Dark Pools” has been troubling, because it hindered price discovery. The next question is has merger led to lower execution costs? It is not entirely clear – manly because the dark pools may have forced the exchanges to lower execution costs. There is no doubt (and empirical analysis proves this) that less developed markets benefited greatly from mergers. Introducing innovations and generating additional liquidity. The replacement of market makers system has proved to be generally an improvement (also dramatically reducing transaction costs).
So Dark pool have helped reduce commission costs, but have hindered the price discovery process, which introduces additional inefficiency, but this arose out of the slowness of the markets to adapt. The same can be said of high frequency trading platform, which act as an ultra efficient (and fast) price discovery tool for certain hedge funds.
Aside from the premium that arises from an acquisition it is difficult for shareholders to value a merger of two exchanges. Ideally, bigger market share enable additional efficiencies (economies of scale) – however, stock market cross border transactions are different. Each jurisdiction must maintain data within the original country, and abide by local regulatory requirements. This limits the scope for cost consolidation, and therefore cost savings. In fact, aside from the cost of the merger (and the massive payoffs to each exchange’s board & senior management), shareholders are unlikely to see much value.
The econometric analysis of the merger of stock markets over the past 10 years reached the following conclusions:
(1) Liquidity for large market cap firms rose
(2) Mid cap and small cap saw virtually no change in liquidity
(3) Technologically “backward” markets benefit with better execution, and were “pulled up” by the more mature/advanced markets (Portugal’s stock market is the best example).
(4) Benefits are mergers were asymmetric, but the winners share no common attributes.
Looking at the merger being contemplated now, the problem is that they are all mature with limited scope for technological leaps. There will be winners and losers but they cannot be predicted.