Table no. 1 Ten largest domestic equity market capitalizations

ASPECTS REGARDING THE ACTIVITY OF EXCHANGES FROM EUROPEAN UNION Matei Mirela Petroleum and Gas University, 39, Bd Bucuresti, Ploiesti, Prahova, 0244/575312, mirematei@yahoo.com Commodities and stock exchanges are rallied in a tough competition with the OTC markets and banks in order to gain customers. For this reason, it is a consolidation trend in this field, many exchanges merged or bought other exchanges or OTC operators or clearing companies. On European continent, this trend is strong because the public authorities, which want to create an integrated European financial market, sustain the private initiatives. Individual and institutional investors wish to derive the maximum benefit from financial markets using speculation and hedging operations. In order to gain much, investors are interested on international markets because they try to reduce the risk through portfolio diversification or to have access to innovative products launched by foreign stock exchanges. In order to meet their clients demand, the exchanges are in a development process, characterized by innovation of financial products. So, the classical futures and options products are used only on exchanges from developing and transition countries. Key words: exchanges, innovation, integration, and consolidation 1. Importance of exchanges from European Union At international level, it is a tight competition between American and European exchanges. Till now, the American exchanges are leaders, but the European exchanges try to balance the forces and they are rallied in innovation process. Table no. 1 Ten largest domestic equity market capitalizations Exchanges 2006 (bn USD) 2005 (bn USD) % change 1 New York Stock Exchange NYSE 15,421 13,311 15.9 % 2 Tokyo Stock Exchange TSE 4,614 4,572 0.9 % 3 NASDAQ Stock Exchange 3,865 3,604 7.2 % 4 London Stock Exchange LSE 3,794 3,058 24.1 % 5 Euronext 3,708 2,707 37.0 % 6 Hong Kong Exchange 1,715 1,055 62.6 % 7 TSX Group 1,701 1,482 14.7 % 8 Deutsche Borse 1,638 1,221 34.1 % 9 BME Spanish Exchanges 1,323 960 37.8 % 10 SWX Swiss Exchanges 1,212 935 29.6 % Source: Market highlights 2006, World Federation of Exchanges 2007, page 1 As the figures show, the most important stock exchange is New York Stock Exchange, but the European exchanges try to fill the gap. In this order, the most active exchange is London Stock Exchange and Euronext. The force of Euronext can be explicated by the mergers of exchanges from five countries: France, Belgium, Portugal, Great Britain and Nederland. 432

Table no. 2 Top 10 exchanges by total value of share trading Exchanges 2006 (bn USD) 2005 (bn USD) % change 1 New York Stock Exchange 21789 14125 54.3 2 NASDAQ Stock Exchange 11807 10087 17.1 3 London Stock Exchange 7583 5674 33.7 4 Tokyo Stock Exchange 5825 4427 31.6 5 Euronext 3805 2901 31.2 6 Deutsche Borse 2742 1912 43.4 7 BME Spanish Exchanges 1941 1568 23.8 8 Borsa Italiana 1596 1300 22.7 9 SWE Swiss Exchange 1396 975 43.0 10 Korea Exchanges 1340 1204 11.2 Source: Market highlights 2006, World Federation of Exchanges 2007, page 1 For bonds, the most important exchanges are the European ones. The first rank belongs to BME Spanish Exchanges and London Stock Exchange, OMX, Euronext, Deutsche Borse, Borsa Italiana and Swiss Exchange occupy the next ranks. At international level, Deutsche Borse is on the first rank for covered warrants, the value traded being of USD 285,9 bn. At four ranks is other European exchange Borsa Italiana with a value traded USD 91,2 bn. Exchange traded funds (ETFs) launched in 1990 by Toronto Stock Exchange, have a great success after they have been introduced on American Stock Exchange in mid 1990. In present, the global leader position is occupied by New York Stock Exchange with a value of ETFs traded by USD 2146,9 bn. Exchange traded fund (ETF) is a basket of securities such as national and international stocks, corporate bonds and treasury bonds. There are many types of ETFs based on shares issues by large-capitalization or small-capitalization companies, stocks of European, American or Japanese companies; shares of companies that activated in a specific domain like healthcare, energy, and long-term Treasury bonds and corporate bonds. The expansion of these products is due to their main advantage: the low risk because of the diversification of portfolio. In addition, the ETFs can be purchased on margin or sold short like shares or bonds. In this field, the position of European exchanges are modest, Deutsche Borse, and Euronext are on rank three and four, but the values of ETFs traded are low USD 99,5 bn and USD 44,5 bn). 2. National and cross-border mergers and acquisitions The mergers and acquisitions are a reality of our time. At international level, this phenomenon is highly present in finance sector. In banking sector, mergers and acquisitions have led to set up of financial groups and transnational corporations. At exchanges level, the result is establishment of strong entities, which provide many operations and products. The mergers and acquisitions take place at national level, but also between exchanges from different countries. In Germany, Berlin Borse has merged with Bremen Stock Exchange; Hamburg Hanseatic Stock Exchange and Lower Saxony Stock Market at Hanover merged and formed BOAG Borsen AG. In august 2002, Athens Stock Exchange and Athens Derivative Exchange was transformed in Athens Exchange. This process of national consolidation is available also in Spain, where a new holding company was created and comprise all the Spanish markets (Madrid, Barcelona, Bilbao and Valencia stock exchanges, MF Mercados Financieros, Iberclear and BME Consulting ) under the name of Bolsas y Mercados Espanoles. The mergers and acquisitions focuses not only on stock and commodity exchanges but also between exchanges and over the counter markets. In July 2006, Chicago Mercantile Exchange (CME) bought Swapstream based in Great Britain. Swapstream is the market-leading multilateral electronic trading platform for interest rate swaps. After acquisition, Swapstream operates, as a wholly owned subsidiary of CME and it remains based in London. In Romania, in 2005, Bucharest Stock Exchange took over the OTC market RASDAQ. So, the consolidation process is a reality in developed and developing countries, the reason being the necessity to establish strong markets that could be able to compete with American exchanges. But the process of consolidation is obvious in USA, too. In order to deliver significant efficiency to their global customers, in October 2006, Chicago Mercantile Exchange and Chicago Boar of Trade announced their mergers for the midyear 2007. In European union, this process of integration of stock exchanges is reinforced by the introduction of euro. Using a single currency in European Union, the companies have increased their cross border securities business, 433

but they must reduce the cost and complexity of international trading. So, the stock exchanges are obligated to meet the needs of their clients. In order to facilitate the securities business on Europe, in 2000, exchanges from Paris, Bruxelles and Amsterdam merged and a new exchange was settled up Euronext. But the process of development continues with the acquisition of London Financial and Futures Exchange (LIFFE) in January 2002 and of stock exchange from Lisbon in February 2002. From November 2004, there is a single trading platform for spot market and on for derivatives transactions. In European Union, the legal harmonization and regulatory initiatives are important aspects in the achieving of an integrated securities market infrastructure. For futures and options operations, two European exchanges - Deutsche Börse AG and SWX Swiss Exchange has created a derivatives subsidiary Eurex. Eurex offers a great variety or products, like credit derivatives, ETFs derivatives and volatility index derivatives. In addition, Eurex Clearing provides central counterpart services not only for financial instruments traded on Eurex but also on other exchanges like Frankfurt Stock Exchange and Irish Stock Exchange. So, the developments of information and communication technology have influenced the consolidation of securities trading. In addition, in 2003, on the European continent, it was settled an integrated trading platform, named EDX London with offer access to London Stock Exchange, and exchanges from Stockholm, Copenhagen and Oslo. By this platform, the investors have access to over 150 type of futures and options contract on index and stocks. This initiative was launch by OMX AB and is based on concept of linked exchanges. In this way, the investors have a facile access to spot and derivatives markets using one brokerage company, which acts on a single order from its client. But the mergers and acquisitions take place between exchanges from different continents. The most important example is the merger between New York Stock Exchange Group (comprises New York Stock Exchange and NYSE Arca, the former Pacific Exchange) and Euronext. The result was the set up of NYSE Euronext holding company in 4 April 2007, the most liquid and largest exchange group from the world. This group comprises six cash equities exchanges from six countries and six derivatives exchanges. The shares of the new company are traded on Euronext in Paris and on NYSE. In spite of the benefits of mergers and acquisitions, on European continent, London Stock Exchange rebuffed the bid from Euronext, Deutsche Borse, Australian bank Macquarie and NASDAQ, the reason being the low price offered by investors. The securities infrastructure in European Union is still fragmented, with a big number of national exchanges, central counterpart clearing house and central securities depositories. (Schmiedel H., Schonenberger A.2005) 3. The innovation process of financial products Traditionally, the commodities and stock exchange provides spot, futures and options markets for a broad range of products like coffee, cocoa, cotton, juice, ethanol, metals, currency, interest rate and indexes. These products are used for speculation and hedging strategies. Because, the companies identified many factors of risk, the exchanges try to provide adequate products for different type of investors. Listed companies can enhance their image in the eyes of investors by hedging their exposure to risk. The exchanges try, in this way, to compete with OTC markets, banks and insurance companies that offer many solutions for hedging. The weather can have a major economic impact on corporate cash flows, costs and earnings. The temperature swings; rainfalls, snows or sunshine can affect, in different ways, companies from many industries such as farming, constructions, energy, food, clothing, airlines, leisure or travel. In order to help companies to reduce the weather risk, weather derivatives (swap, cap, floor, collar, futures and options) are available (Campbell S,. Diebold F.,2003). Aquila Energy made, on OTC market, the first transaction using weather derivatives in 1997, in USA, and the market has been growing ever since. In 1998 the market was estimated at USD 500 million, more recently the market has grown to more than USD 5 billion and has a better liquidity. In Europe, the market is smaller than in the USA, but growth prospects are excellent, owing to the liberalization of energy markets and a growing appreciation of weather-related issues. The development of the European market for weather products are sustained by banks and insurance companies. In addition, the over-the-counter market for weather derivatives in Europe has expanded sharply. Until now, weather derivatives are available only on Chicago Mercantile Exchange that launched the first contract in 1999 using the temperature from American cities. The weather contracts traded on exchange are futures and options contracts that used as underlying assets different indexes for temperature, wind, rain or snowfalls. The interest of European investors determined the launching of contracts for five European cities. At 20 June 2005, the weather contracts are for 18 American cities, 9 European cities and 2 Japanese cities. Homes are the major asset for investment for many people and the housing industry creates jobs and determined investments in related sectors. The importance of this industry has led to creation of derivatives using index of real estate price. The idea of creation of such an index belong to Case, Shiller and Weiss with articulated the concept of real estate futures in 1992. The first exchange that lists futures and options based upon index of real estate prices was Chicago Mercantile Exchange. Euronext fallowed this initiative in 2004. Euronext and Institute de l Épargne Immobilière et Foncière (IEIF) have launched the Euronext IEIF "SIIC France" index that is based on listed real-estate investment companies that have opted for a new tax regime known as SIIC2. The last innovation was credit derivatives contracts that are available from march 2007 at Eurex. Companies try to hedge the risk of credit default and use credit derivatives. Initially, these types of derivatives were launch on OTC market. At international level, the market for credit derivatives has been growing fast, increasing from USD 1 trillion in 1996 to more than USD 20 trillion in 2006. The contracts from Eurex are based on itraxx indexes provided by International Index Company Ltd. These indexes are following the performance of 434

investment grade or sub-investment grade credit default swap entities from Europe. The main reason for Eurex to launch these products is the investors necessity to have standardized contracts for hedging the credit risk. The straight delimitation between commodities and stock exchanges are difficult to do, because the demands of the investors forced the exchanges to launched different products. For example, London Stock Exchange (LSE) offers the possibility to invest and make business with commodities through new products named exchange traded commodities (ECTs). ECTs are investment vehicles that track the performance of an underlying commodity index. On LSE, 19 individual securities based on commodities (like natural gas, crude oil, gold, sugar) and 10 index securities on groups of commodities (metals, grains, softs) are available now. These products are available for investors, which want to speculate or to hedge the risk of their portfolio because the commodities have low correlation to equities and bonds. In fact, the initiative belongs to a private company named ETF Securities, which launched the first ETC in 2003 in Australia. From September 2006, company listed an entire platform of ETCs on Euronex Paris and Amsterdam, LSE and Deutsche Borse. 4. Conclusions The competition among commodities and stock exchanges has major benefits for investors. In order to be more efficient, exchanges try to initiate a process of consolidation through mergers an acquisition at national and regional level. The effects are multiple for exchanges involved and for investor: generation of massive synergies from IT activities and innovative activities, the existence of multi-product regional or global exchanges, further business development, benefits for companies listed on exchanges like visibility to investors. On European continent, this phenomenon is highly visible, the private initiatives, the efforts of authorities and the introduction of euro sustained the process of financial consolidation. The main problems rising from mergers and acquisitions in regulations and supervision of exchanges, because the groups or alliances created comprised exchanges from different countries, with different laws and supervisor bodies. So, it is necessary to create regional and international laws and bodies. In this field, the European experience could be useful for other countries and exchanges. Because the transactions on the over the counter markets are more developed, the exchanges bought such institutions. In addition, exchanges have inspired in the process of launching investment products and in order to facilitate the transactions, they offer standardized contracts like credit derivatives. To meet the investors needs portfolio diversification and risk hedging many exchanges created structured products like exchange traded funds and exchange traded commodities. Specialists from European Exchanges have tried to launch standardized products for unstandardized aspects like economic process (such as volatility) or real estate prices. All these new contracts are used primarily for hedging strategies, but also for speculative operations. So, exchanges try to compete with other financial intermediates like insurance companies. Competition is on geographical level, between European and American exchanges, and on sector level, between exchanges and other financial companies that provide hedging products like banks and insurance companies. 435

5. References 1. Schmiedel H., Schonenberger A, Integration of securities market infrastructures in the euro area, European Central Bank, Occasional paper series, no 33/2005, page 22 2. Campbell S, Diebold F., Weather forecasting for weather derivatives, National Bureau Of Economic Research, Working Paper 10141, http://www.nber.org/papers/w10141, December 2003, page 3 3. www.euronext.com 4. www.eurexchange.com 5. www.londonstockexchange.com 6. www.world-exchanges.org 436