The London Stock Exchange (LSE) is one of the largest and most iconic exchanges in the world. While most people have heard of the LSE, few understand its business model, sources of revenue, the overall industry structure, as well as the regulatory and competitive landscapes facing the LSE.
Reole in the European Market
The London Stock Exchange Group Plc (LSE) is Europe’s leading diversified stock exchange group, created through the incorporation of Borsa Italiana, London Stock Exchange, and MillenniumIT. Through these subsidiaries, the LSE operates diversified exchange platforms for international equities, fixed income, and derivatives markets in Europe. The LSE provides its clients with a diversified offering through its ability to develop and provide innovative products and services across a range of asset classes that respond to both the evolving needs of investors and the changing dynamics shaping the industry. The LSE is actively engaged in the admission and listing of securities for trading, the distribution of exchange platforms and trading systems, post-trade clearing and settlement services, the distribution and provision of real-time market data, technology and information services, and the coordination and regulation of securities markets.
The London Stock Exchange operates four distinct business segments, which contribute to the Group’s ability to offer diversified exchange trading services. Its Capital Markets division assists companies with raising capital (both debt and equity) for investment purposes as well as providing investors with access to deep and highly liquid secondary markets which facilitates greater ease of trading and also serves to reduce the cost of capital for these firms. This business segment has also had success in the primary markets, experiencing a recent increase in the number of new companies listed on the Group’s exchanges through initial public offerings. Through its subsidiaries, the LSE lists in excess of 3,000 companies on its equity markets and provides clients with the ability to trade equities, fixed income, and derivative products on exchanges across Europe. The LSE’s Post Trade Services segment offers a broad range of risk management services in addition to securities clearing, settlement, and custody services facilitating the successful completion of trades. This segment has readily adapted to the recent policy reform impacting the post-trade landscape by making an adjustment to how the Group manages its clearing services (through CC&G and Monte Titoli) across multiple exchange platforms. Additionally, this division has diversified its post-trade services to more efficiently manage counterparty risk, trade matching, and confirmation. The Information Services division delivers to clients an expansive set of real-time, reliable market data, including data on trading volumes, share prices, index information, current and historical data, and company announcements. The objective of this segment is to provide investors with “extensive market intelligence” for the purpose of strategic decision making.
The LSE has significantly expanded its information management systems (primarily through acquisitions) including Proquote, UnaVista, SEDOL, and Turquoise to better serve the trading information and market data needs of its clients across a range of asset classes. The LSE’s Technology Services segment delivers, implements, and supports technology platforms and trading software for clients of its subsidiaries – Borsa Italiana, London Stock Exchange, and MillenniumIT. This division works to optimize the speed, performance, connectivity, and trading flexibility of its exchange platforms as well as to deepen the scope of its technology offering by successfully adapting to technological innovations in order to maintain the LSE’s leading edge in the speed and efficiency of its technology capabilities. The vast breadth and scope of the LSE’s service offering, evidenced by the end-to-end provision of trading services through its four business units, clearly demonstrates the Group’s significant diversification within the exchange trading industry. This diversification is in large part the value proposition that the LSE offers its clients, investors, and capital market participants.
Growth Strategy and Structure
London Stock Exchange’s strategy for growth is structured around three strategic imperatives: “getting in shape,” “leveraging assets,” and “developing opportunities.”5 “Getting in shape” refers to the LSE’s vision to increase the efficiency of the products and services provided to its clients. The Group is currently pursuing initiatives to improve the operational management of its technology services aimed at reducing costs; affording the LSE an advantageous position relative to competing for exchange firms which face intense price competition. Furthermore, the LSE is working to develop incentives to increase volumes and boost overall competitiveness through new tariff structures in an effort to create a need among investors for its increasingly streamlined and efficient service offering.
The strategic focus on “leveraging assets and developing opportunities” refers to the LSE’s strategy to improve its ability to serve customers across the globe by increasing the scale and scope of its operations. The LSE has positioned itself to achieve this objective primarily through strategic mergers and acquisitions that closely align with the Group’s overarching business strategy. The LSE has pursued a series of recent acquisitions and strategic partnerships that have enabled the firm to remain competitive within the industry and to keep pace with the evolving demands of its clients and investors. These acquisitions have served to expand the geographic presence of the Group’s exchange operations – penetrating previously untapped markets in Mongolia, Japan, India, Scandinavia, and Sri Lanka. In addition, these strategic partnerships have enhanced and further diversified the scope of its service offerings in trading and exchange and promoted the globalization of capital markets and development of market relationships by providing networking technologies and exchange trading platforms. These various strategic initiatives – and in particular the alliances, business partnerships, and merger and acquisition activities – pursued by the LSE are in large part driven by the Group’s ambition to be “a world-leading diversified exchange group.”6 Taken together, this three-pronged growth strategy has been developed to afford the LSE the financial and operational flexibility to respond to the dynamic forces shaping the financial markets and position the Group to remain a competitive and dominant participant in the exchange trading industry.
As one would expect, the London Stock Exchange is a heavily regulated entity as it is at the backbone of capital markets and the entire financial system requires trust and security. The Financial Security Authority (FSA) is the primary regulator of the London Stock Exchange. It oversees trading firms and investing institutions, securities trading, clearing and settlement, and trading venues such as the London Stock Exchange. On June 7th, 2010, George Osborn, the Chancellor of the Exchequer finalized plans to abolish the FSA and release the responsibility of policing the city and the new banking system to the Financial Conduct Authority (FCA). This transition will be overseen by Hector Sants, the current Chief Executive of the FSA, and will be completed by the end of 2012 to ensure market confidence, financial stability, protection of consumers, and that the reduction in financial crime is monitored under one statutory body.
The introduction of an amended law known as the Markets in Financial Instruments Directive (MiFID), implemented in 2007, obligated companies to report using an Approved Reporting Mechanism (ARM) to detect and investigate cases of market abuse, insider trading, market manipulation, and also as a part of monitoring of supervised firm activity. Subsequently, the FSA developed its own ARM called the Transition Reporting System (TRS). Since the LSE operated its own Approved Reporting Mechanism, the UnaVista platform, the FSA entered into an agreement to sell the TRS to the London Stock Exchange to fulfil ongoing reporting obligations and to migrate current TRS customers to the UnaVista Platform. This was yet another one of the LSE’s recent acquisitions.
The Financial Markets Security Act (FMSA) of 2010 outlines the objectives to maintain market confidence, securing the appropriate degree of protection for consumers, fighting financial crime, and contributing to the protection and enhancement of the stability of the UK Financial System. The FSA and the FCA (the foreseeable successor to the FSA) have established that the LSE will continue to meet these regulatory standards in the event of a take-over.
Security & Commodity Exchange
The exchange industry is aggressive and highly competitive. While the London Stock Exchange competes directly with three major exchange firms – NYSE Euronext Inc., NASDAQ OMX Group Inc., and Deutsche Boerse AG – the Group also faces intense global competition from existing and new exchange firms. Given the recent trends toward globalization and the liberalization of international capital markets, this has resulted in a significant increase in capital mobility among international market participants thereby intensifying the competitive pressures among exchange firms in their competition to attract securities listings and trading services across a broad range of asset classes. Exchange firms also compete with market participants on “the cost, quality and speed of trade execution, market liquidity, the functionality, ease of use and performance of trading systems, the range of products and services offered to customers and listed companies, technological innovation and reputation.”
As mentioned earlier, the Markets in Financial Instruments Directive (MiFID) was implemented in 2007 with one of the main goals of increasing competition in financial products trading. As part of this, multilateral trading facilities or MTFs came into existence as an alternative to the “incumbent” exchanges. This meant that the trading of UK securities, for example, no longer had to be transacted over the London Stock Exchange, as new exchanges existed to handle these orders. The MTFs are the most formidable competitors to the London Stock Exchange. Looking at the FTSE 100 index (UK-focused), the LSE still has the largest market share of trading of 51.79%. However, MTFs have a very significant share of the market: Chi-X has a 31.44% share, Turquoise (acquired by the LSE in 201027) has an 8.74% share, and BATS has a 7.83% share. Other exchanges, such as the NYSE, facilitate a negligible amount of trades.
The London Stock Exchange generates revenue from the four major activities noted above. In the capital markets segment, the London Stock Exchange charges companies for listing on its exchange based on the market capitalization of the company and annual fees thereafter. Admission fees would be roughly £57,000 for a firm with a market capitalization of £250M, whereas the annual fees are £5,350. Fees are also charged for secondary issues and public announcements. It also assesses membership fees on firms that belong to the exchange (£10,000 to join and £12,500 annually). The LSE even earns money on each trade that is executed, and the pricing follows a tiered structure, such that the cost ranges between 0.20bps and 0.45bps based on the value of equity and derivative orders executed. 10 The capital market segment generated 42% of the exchange’s revenue.
Post-trade services relate to clearing and settlement of trades as well as custody of assets. Once a trade occurs, a clearinghouse essentially guarantees the trade and nets all of the buys and sell orders of firms. The settlement process involves assets being transferred between parties and the custodian can hold and service the assets on behalf of these parties. In FY2011, the LSE cleared roughly 116 million contracts, processed 70 million settlement instructions, and was the custodian for over €3 trillion of assets. It also generated revenues through treasury services afforded to firms whose trades were cleared. Post-trade services accounted for £150.6M or 23% of the firm’s revenue.
Information services relate to real-time data feeds of pricing and trading data. The 2011-2012 price list shows that data licensing (to disseminate the data outside the organization) can range from a few thousand pounds per year to over £45,000, depending on the type of customer and the medium through which the data is transferred. Other data feeds are only a few hundred pounds per month. 93,000 subscribers access LSE data and 139,000 access Borsa Italiana data through these services. The LSE collects other fees for providing access to other exchange data services and systems as well. One example is Proquote which is a desktop tool that can display “quotes, news, and security profiles.” This area accounted for £184.7M or 27% of the LSE’s revenue in the most recent fiscal year.
Lastly, the technology services segment is comprised mostly of revenue from MillenniumIT which is an Indian company specializing in capital markets’ systems and was acquired by the LSE in 2009. The LSE’s main objective in purchasing this firm was to transition clients from its current trading platform known as TradElect to Millennium’s new system which can handle multiple asset classes and has extremely low latency which is a major differentiator amongst exchanges. Millennium Exchange’s latency is under 1 millisecond versus 1.41 for TradElect. Other services reported under this segment include co-location services which allow firms to take hosting space in the LSE’s data centre to ensure rapid execution. Order routing services also contribute to sales. This group contributed just 7% of the company’s sales or £48.6M.
It is obvious that the market conditions greatly affect the London Stock Exchange’s sales and profitability. Much of the firm’s costs are fixed and therefore a decline in sales hurts the bottom line. The capital markets segment is heavily dependent on market conditions have given the fact that the LSE generates money based on trading volumes and market values of new issues. Moreover, all post-trade services are predicated on market conditions as they are all tied to trading volumes. In terms of information services and technology services, these areas seem to be in high demand, yet pricing pressures from the competition can hurt the exchange’s income as well.
Address and Contact
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Postal address: 10 Paternoster Square, London, EC4M 7LS