WORLD FEDERATION OF EXCHANGES
This heightened reliance on public capital
markets has been taking place in many
countries around the world, involving by far the
greater part of the world’s economic life.
Exchanges’ centrality to social wealth creation is
established. Corporate treasurers need to factor
in their ability to tap this source of cash by
issuing securities, just as finance ministers try to
balance national budgets with their privatizations
of state-owned businesses. Public awareness of
the need to invest has prompted great individual
interest in equities and related exchange-traded
products, too. A further benefit has been the
broadening of share ownership, and with it the
loosening of market forces for better corporate
governance practices.
Exchanges Establish Fair Rules for Efficient
Markets
Exchanges have a distinct, market-neutral
identity within the financial services sector. They
are not insurance companies, investment firms,
banks, or brokerages. They operate regulated
securities and derivative markets. These markets
establish asset values through efficient price
discovery, enabling the public to know how
much companies are worth according to the
latest news and economic outlook.
Putting together rules, know-how and
technology for transparent trading of assets
worth three quarters of one year of the world’s
GDP is quite a responsibility; to meet that
challenge is to assist in building prosperity.
Regulated securities exchanges provide
solutions by creating greater efficiencies across
the public capital markets value chain, and
diffusing ever more complex and better quality
financial information to support the work of all
actors.
This essay now moves on to state some of the
business questions exchange operators face.
A financial market is highly sensitive to its
environment; operating an exchange is a
proportionately complex business. Regulation
helps make the markets more efficient, but
much also depends on human talent and
judgment, just as is the case elsewhere in the
financial services industry. Governments are
profoundly involved in matters of public savings,
as are the corporate issuers of securities and
the investors themselves; together with them,
operators of exchanges must often fine tune
rules to keep this business model right. Today,
the scope of this business underscores the dual,
simultaneous national and international challenge
that the functioning of these markets represents.
For fair and transparent price discovery to occur,
the business of exchanges precedes the instant
of trade order execution and extends well
beyond. Even if by law or custom the exchanges
in every country do not operate these diverse
activities directly, their involvement in them is
extensive. The bundle of related businesses is
what builds a coherent, secure market. The
entire value chain must function smoothly,
including:
• writing the rules for market activity
• admitting intermediaries (banks or brokers)
to act on the central market
• assuring the ability in-house to follow
intermediaries’ positions, and so establish
enforcement of market rules
• admitting securities to listing
• assuring on-going disclosure of corporate
information
• setting up adequate IT and communications
systems facilities
• diffusing of market information to a wide
public
• trading
• assuring prompt and final clearing and
settlement of orders
• providing for securities registry, transfer
agent, and depositary activities
In addition to equities, Federation members
conduct nearly all of the world’s on-exchange
trading of government and corporate bonds,
derivative instruments, investment funds,
exchange-traded funds (ETFs), warrants, and
convertible bonds. Also in this commercial
environment, exchanges are extending further
into after-trading services in search of good
returns in related business fields.
The Business of Running Exchanges
Whether a for-profit company or a cooperative,
exchanges must serve their customers and earn
money to ensure business growth. This means:
• improving staff operations and competency
• rewriting rules as know-how, technology,
products and opportunities gradually modify
the market and create new challenges
• scaling up IT and telecommunications
systems
• connecting markets to ever more players
• enhancing surveillance and control
functions. Actors, instruments, and types of
securities are growing in complexity, and
trading in them interacts more intensely, often
across borders.
• improving the information disclosed on
companies and market data
• leading improvements in how corporations
are governed
• addressing strong national and cross-border
competition
• investing reserves strategically
• assuring a good return on capital
• organizing programs for educating users of
the exchange business
A growing number of exchanges have
introduced the shares of their companies on the
markets they operate, emphasizing at the same
time the for-profit and public nature of this
industry.
With this mix of questions in mind, it is notable
that technologies and efficiencies at exchanges
have enabled them to lower unit costs
throughout the 1990s and afterwards. Up until
the end of 2002, total revenue growth was
strong over this period at 300%, and notably
lower than the 395% increase in annual trading
volumes. The benefits of scale and technology
were passed on to customers in lower charges
to clients.
Challenges for Exchange Managers
There is a public good in operating an
exchange, and managers certainly recognize the
importance of this. Bourses are not the only
segment of financial services to have this
distinction. However huge the markets relative to
the economy, in the end, exchanges are about
running regulated businesses. On balance, one
cannot have regulation without a prosperous
business environment, and one cannot have a
prosperous exchange without clear rules and
respect for them.
Intangibles matter to exchanges: their market-
neutral position, and the value of their reputation
for fairness and transparency in the conduct of
trading. Managers do their utmost to enhance
the quality of these assets, for they are
commercial elements central in running the
business.
The question is sometimes implied that the
quality aspects of the business, the assurance
of regulatory services, is not entirely compatible
with a for-profit environment. Yet all businesses
must assume costs of quality for goods and
services, whatever the industry. In many
jurisdictions exchanges are subject to particular
questioning on this point, while the economic
scale of this industry, and the market statistics,
demonstrate that market mechanisms are
functioning properly. Volume growth and
reduced bid-ask spreads underscore the
operating efficiency of exchanges.
The size of the exchange industry is small
compared to the economic function of the
markets. Including consolidated companies,
Federation members at the end of 2002
employed 22,062 people, and operated off a
total capital base of US$ 13.4 billion.
The corporate size of exchanges is also small
compared to banks, insurance companies,
institutional brokerages and other investment
firms. Each has key financial functions to fulfill,
including in the capital markets. But given the
complex work of exchanges and their centrality
to economic life, their relative size often means
that these managers are not sufficiently heard in
public financial policy debates. The public
agenda may be too keyed to issues of banking
and insurance; but for successful
macroeconomic management, the figures in this
paper demonstrate the need for greater focus
on regulated exchanges. Their success cannot
be taken for granted, and the experience of
bourse managers must be drawn upon and
used as a key tool in devising public policies.
Exchanges need independence and freedom to
operate within the rules of the regulatory
environment. There can be unintended
consequences of too much regulation that will
impede the market function. The goal to pursue,
the hard balance to find, will involve unleashing
the full benefit of an exchange within the set
rules of the local jurisdiction, remembering that
there will never be a situation of zero risk for
investors or issuers, and that governments
should not be aiming for that objective. That
simply is not what financial markets are about,
and even to imply that would give a poor sense
of this business.
In trying to take business off the bourse, many
other financial actors criticize the central role
exchanges fulfill. Some commentators underplay
the competitive pressures Federation members
feel as enterprises. In acting in this way, they
harm to price discovery on central markets,
undermining a mechanism that clearly provides
a social good.
Also, in some jurisdictions experimentation with
market structure has led to sharp falls in trading,
notable widening in bid-ask spreads, or higher
costs to final clients–all of these being sure
signs that the market has become less efficient.
Exchange managers must be involved in
regulatory planning, so that adaptation to
changing commercial conditions in finance is
taken into account. The investing public and
listed enterprises must not be disadvantaged.
As a social responsibility, and as an essential
part of further business development, exchange
managers come forward as leaders in public
debates on capital markets, and to correct
inaccuracies in the discussions about regulated
bourses. Most recently, they have been
strengthening rules and helping to have
legislation enacted that will hold corporate
leaders to higher standards. Exchange
enforcement of market rules has been
reinforced, too. Together these measures will
renew and enhance the confidence needed
between public listed enterprises and investors.
FEDERATION OF EURO-ASIAN STOCK EXCHANGES YEARBOOK 2003/2004
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