COVER STORY - In the market for a new deal

The appointment of Clara Furse as the fourth chief executive of the London Stock Exchange in less than a decade drew attention yet again to the crises it has faced in recent years and the difficulty it has had in developing a coherent strategy. Furse, and chairman Don Cruickshank, will have to work quickly to establish the credibility of the exchange and its management if it is not to be swallowed up or run into the ground by smarter competitors. But before Furse can start finding answers, she will have to focus her mind on what the right questions are.

What is the London Stock Exchange for?

Get the answer right to this question and a lot of other answers will start to fall into place. First of all, it’s worth bearing in mind what the stock exchange isn’t these days. It isn’t a marketplace – there is no exchange inside the stock exchange tower – nor is it even a regulator.

Virtually all regulatory powers over how listed companies conduct themselves while floating and afterwards have been handed over to the UK Listing Authority, part of the Financial Services Authority. Even its monopoly position as a supplier of regulatory company statements (profit announcements, share holding statements, etc) is under scrutiny.

This, of course, makes what the stock exchange does easily transportable overseas. Unencumbered by premises or local regulation, it is effectively little more than a technology, a share-trading platform that can be adopted almost anywhere. What’s lacking, however, is the settlements side, which is handled by the completely separate businesses, Crestco and London Clearing House.

It is open to debate whether this more mobile stock exchange ought to change its name, scrap its centuries-old crest and drop its motto – Dictum meum pactum, My word is my bond – to make its services more attractive to foreign multinationals looking for somewhere to have their shares traded.

Who are the LSE’s customers?

Until its partial flotation last year, the London Stock Exchange was a mutual organisation, owned and run by, and for the benefit of, the member firms. They were, of course, charged for the market services that the LSE provided, and they had to undertake considerable expenditure of their own to be able to work with the developing trading and settlement platforms.

But there was, essentially, a one-to-one relationship between the owners and customers of the exchange, just as there is with any mutual organisation.

The companies that paid to be listed on the exchange were not really “customers”: there was little likelihood that any UK company would take its main stock exchange listing to New York or Frankfurt. Hence, the LSE was essentially a monopoly supplier to listed companies. The same went for the share price and news information services it charged for.

Not now. As equity capital is increasingly global the largest companies can take their listing where the money is, rather than list with their domestic exchange. When a monopoly is no longer a monopoly, then greater efforts must be made to provide what they want. And what they want, as GlaxoSmithKline FD John Coombe told Financial Director last year, is “the most efficient mechanism for having their shares traded” so as to reduce the cost of capital.

Moreover, as the LSE’s existing owners, the stockbroking firms, buy and sell their shares in the LSE, the shareholding base will gradually shift – or perhaps not so gradually once the 4.9% shareholding cap is lifted, as is now proposed. So rather than the one-to-one relationship between owners and customers that the exchange enjoyed, it’s going to have to confront the fact that its customers are now, more than ever, the companies that list on it, and the owners may well be institutional investors. They are going to be as interested in how the LSE delivers shareholder value as in the quality of its services.

This change has raised fears that Furse has been brought in to flog the exchange to the highest bidder. Certainly, it is sitting on considerable assets: more than #200m in cash plus an ugly 1960s building that’s worth over #100m. Still, fattening up the exchange for sale is probably not part of the Furse strategy. But she will be under no illusion that her customer base and her shareholders are beginning to have differing interests.

A further complication is that small, slow-growing customer companies – the ones that don’t qualify for the FTSE-250, nor for AIM or techMARK – aren’t as attractive for the LSE as global blue chips or fast-moving new economy stocks. Will they be overlooked in the rush to attract new business?

How will you restore confidence in the LSE’s management?

The last eight years have seen Furse’s three predecessors depart under a cloud – the most recent casualty being almost literally booed off stage. Last year saw the failed attempt to merge with Frankfurt’s Deutsche Borse and the aborted hostile bid attempt from Swedish stock exchange operator OM Group. The LSE boardroom needs to get itself sorted out.

So far, though, Furse has been reluctant to say much about her strategy, a few quick decisions have been made and a few ideas floated. The balance sheet is being cleaned up with the proposal to repay a £30m debenture early, even though it may cost almost #50m to do so. Furse has speculated aloud that the name, logo and motto of the exchange may all be dispensed with.

The major part of Furse’s strategy is going to focus on running the exchange as a business and pressing ahead with a full flotation of the LSE, whose shares currently trade solely on a “matched bargain” basis via blue-chip broker Cazenove. The London Stock Exchange intends to list itself on the London Stock Exchange – perhaps as early as May. A key component of this strategy, however, is to allow existing shareholders to vote on a resolution scrapping the current 4.9% shareholding limit. The effect will be to subject the LSE to the full rigours of the marketplace, as faced by the other companies listed on it.

As recently as last October, however, not long after the departure of chief executive Gavin Casey, the LSE was setting out in its defence document against the hostile OM Group takeover bid, that the exchange should not head for a full listing because “the business is still evolving”, “the benefits of the recent demutualisation have not yet had time to take full effect” and that the “immediate priority is to focus on building the business”.

Perhaps it would have been more accurate to say that the immediate priority was to focus on rebuilding the board: developing a strategy, floating and fighting off hostile bids is not something most companies would undertake without a chief executive at the helm.

At the same time as Clara Furse’s appointment was announced, the LSE said that it was appointing four other non-executive directors and that four existing non-execs were standing down. The aim was to try to inject more independence into the panel of non-execs. The four new members include a QC, the chairman of a Spanish utility and Nigel Stapleton, the highly respected former finance director – and subsequently chairman – of Reed International/Reed Elsevier. The directors standing down included a clutch of investment bankers and stockbrokers and the Bank of England’s nominee.

Presumably Furse was involved in that selection process, which now appears to have been part of an exercise in sprucing up the board for a full flotation of the exchange, making it more Combined Code-friendly.

How will London compete?

Competition has two related aspects: making it as straight-forward as possible for companies to raise capital, and providing an excellent trading platform that does not discourages investors from buying and selling the shares listed on it. Innovations such as techMARK help in the former instance; market liquidity, price transparency and market regulation all feature as desirable attributes in the latter case. The fact that the money and the talent are all in London, making it the leading international financial centre, is helpful – but that’s no cause for complacency. Nasdaq could still eat Furse’s lunch while she’s at the gym, if it wanted to.

One rather tedious area where action is already being taken to make London more competitive is settlement. Investors will shun any market if the administrative hassles, payment delays or general confusion are too great.

The day Furse started work at the LSE, the settlements system moved from T+5 to T+3: three days after a trade is executed, it’s settled and payment is made to sellers. T+1 would be nice, but a significant change in the settlements system would be required. The development of the central counterparty system appears to be a step towards quicker and simpler settlement, allowing investors to net out their settlements rather than pay and be paid gross for each trade. Dematerialisation of share certificates would help, too.

Increasingly, however, global companies want their shares to be tradable globally – so it will not be enough simply to make London a centre of excellence. So …

What partners will you reach out to? Or are you building up a warchest?

A tie-up with Frankfurt is probably a no-no, unless a radically different type of proposal can be put together. So is OM Group. Nasdaq is hotly tipped as its European ambitions are obvious for all to see. Euronext, the French-Belgian-Dutch exchange, has been mooted, but probably lacks the clout of a German or US deal, and probably involves a greater cultural gap than would have existed between the Anglos and the Germans.

By pressing ahead with a full flotation – including scrapping the 4.9% shareholding limit – there must be the possibility that the question of “alliances” will be answered by the highest bidder. With a full stock market listing, in fact, the LSE will be able to use its own shares – as OM Group tried to do – to acquire other exchanges or other businesses. Moreover, the LSE has cash reserves in excess of #210m which could provide a sweetener in any takeover deal. The horrid office block is worth #100m. The exchange has said it will move by the end of 2004 – to Docklands, perhaps. This may explain speculation that Furse intends to scrap the red and white crest, the coat of arms which has symbolic ties with the City of London.

On the day Furse started work at the LSE, Deutsche Borse floated in Frankfurt – and raised EUR908m in cash in the process. That’s “an important acquisition currency”, in the words of Deutsche Borse chief exec Werner Seifert. A would-be ally may become a formidable competitor – or even a hostile bidder.

How will your experience prove valuable?

Danish-Canadian Furse, 43, has been involved with Liffe since its foundation in 1983, initially with Phillips & Drew (which became part of Union Bank of Switzerland), latterly with Credit Lyonnais Rouse, where she was chief executive until last December. She joined the board of Liffe in 1990 and was deputy chairman from 1997 to 1999.

Spectator columnist Christopher Fildes observed that one of multilingual Furse’s strengths is that she can talk to the Deutsche Borse chief “in his own language”. There is also some speculation that the exchange will merge with Liffe, so her experience as a former deputy chairman of the futures market would obviously be useful. But there was a little unnecessary carping in the press about the fact that “she’s never traded a share”.

It’s hard to think of a more irrelevant accusation. Many Liffe contracts – equity index contracts and the traded options market which was acquired from LSE – require Liffe to work closely with the management of the LSE.

Her experience at Liffe has taught her something else, too – about how quickly markets move. Not financial markets themselves, but the market for financial markets. Liffe didn’t exist when Furse started in commodities just over 20 years ago. Yet in two decades, it has gone from the trading floor at the Royal Exchange (opposite the stock exchange) to a bigger trading floor above Cannon Street station, to developing plans for an even larger trading site on the eastern edge of the City – to having no trading floor at all. Competition for financial futures contracts – in particular, ironically, from Deutsche Borse’s Eurex futures operation – meant that the expensive, stripy-jacket, open-outcry system beloved of futures traders and the media was killed off to make way for less glamorous but more cost-effective screen-based trading. As recently as 1997 Liffe was confident that its next new home would be in Spitalfields – within a year those plans were in ruins.

So Furse knows about the competitive threats that the LSE faces, and that the exchange did not cover itself in glory either when trying to merge with Frankfurt or in its attempt to fight off OM Group. An outsider such as Furse – if it’s really possible to call the former chief executive of a City futures business an outsider – is undoubtedly exactly what the London Stock Exchange needs.

THESE DAYS, THERE’S NOTHING TO SEE

A trip to the London Stock Exchange isn’t what it used to be. It’s still the ugliest building in the square mile, but gone are the redeeming features. It’s no longer possible to gaze down on the famous hexagonal pitches on the trading floor. The visitors’ gallery has long been closed, and the floor has become a Knight Securities dealing room. It’s filled with the desks and computers of what is one of the biggest players not on LSE, but on Nasdaq.

Indeed, it’s ironic that the metal plaques in the reception area carry the names “Easdaq” – a pan-European competitor (a minnow, really) which now appears to be cosying up even more with the mightier Nasdaq – and the UK Listing Authority, the branch of the Financial Services Authority that has taken over the regulatory role of the exchange.

Gone are the days when the FT-30 index was calculated and displayed hourly, when settlement of trades took place on a single day about a week after the close of the fortnightly account. Gone are the days when the government broker would don a top hat before walking onto the floor to announce a new gilt-edge stock. Back then – and we’re talking about the mid-1980s, believe it or not – it could take almost five minutes to find out the price of, say, ICI, if the floor dealer was sitting in one of the small windowless “boxes” off the floor of the exchange when the call came through to “check the price and size”.

Gone too are the schoolboy japes. On a slow-trading afternoon, brokers used to quietly set fire to jobbers’ newspapers as they stood reading them. Today, the notice concerning Rule 17, which cautions against the throwing of paper darts, is a framed curiosity in an office on the 19th floor.

Women were allowed onto the floor in the 1970s. In 1986, at the time of Big Bang, the exchange spent millions installing new technology on the jobbers’ pitches. But, within a year of the start of the new order, the pitches were abandoned as jobbers became market-makers sitting in front of screens in offices dotted all around the City.

The most exciting activity at today’s LSE takes place in the Media Centre. Reporters for the BBC, CNN and Sky do live pieces to camera from a building that now has remarkably little to do with the actual business of buying and selling shares.

TRADING HISTORY October 1986: Big Bang results in deregulation, abolition of fixed commission scales, and the end of “single capacity”, by which brokers didn’t make markets and jobbers didn’t deal directly with investors. Ownership cap lifted and international banks snap up stockbroking partnerships. October 1987: Black Monday/Black Tuesday. FTSE-100 falls 20% in two days. 1989: Peter Rawlins named as chief executive of the LSE. 1993: Taurus, the multi-million pound system intended to result in paperless trading, is scrapped. Rawlins departs. Bank of England starts developing Crest instead. Michael Lawrence named as chief exec. 1996: Lawrence departs amid accusations that his “uncompromising” attitude ruffled too many feathers. Gavin Casey named as chief exec. 1997: Launch of SETS trading system. February 2000: Stock exchange demutualises. Shares commence trading on a matched bargain basis via brokers Cazenove. March 2000: Don Cruickshank named as LSE chairman; LSE announces plans to merge with Deutsche Borse to create a new exchange, iX. April 2000: As brokers revolt over the iX plan, Swedish stock exchange owner OM Group makes a hostile bid for LSE. September 2000: Gavin Casey resigns as chief exec amid retail brokers’ revolt over Deutsche Borse merger proposal, which is withdrawn. OM Group bid collapses. January 2001: Furse named as chief exec of the London Stock Exchange. February 2001: Deutsche Borse floats on a valuation of £2.4bn.