For years the conventional wisdom in securities markets has held that consolidation among Europe’s multitudinous stock exchanges is inevitable: Just one or two of the Big Three exchanges -- Deutsche Börse, Euronext and the London Stock Exchange -- will survive; smaller markets must choose a partner or be swallowed up against their will.
Conventional but wrong, says Massimo Capuano, chief executive officer of Borsa Italiana. A former McKinsey & Co. consultant who has headed the Borsa since shortly after its privatization in 1997, Capuano has ignored the consolidation hype, spurning merger overtures and honing the exchange’s competitive position. He has upgraded trading technology, acquired clearing and settlement utilities to streamline back-office processing, expanded in derivatives and launched a separate market for emerging small-capitalization stocks.
Those moves have put the Borsa in robust health, with a rising operating profit and strong trading volumes. Now Capuano wants to secure the Milan-based exchange’s future by forging links between its state-of-the-art clearing and settlement operations and those of other European markets. His logic is simple: Concentrating on back-office consolidation will root out the worst of Europe’s high cross-border trading costs and allow connected exchanges to compete on price and service without sacrificing independence and national identity.
“We have to create systems that allow for connections between our trading platforms and our clearing and settlement to bring costs down, but to get the most out of that kind of cooperation, we should remain independent,” Capuano says. “Our strategy is based on having a very complete and large coverage of the domestic Italian financial market in all its aspects, and I don’t see that threatened by further mergers.”
Capuano’s vision, which would have been dismissed as wishful thinking not long ago, is increasingly in tune with the times. European regulators have cited clearing and settlement as the biggest barrier to a single capital market, and the December merger of the London Clearing House and Euronext’s Clearnet subsidiary promises to deliver the kind of seamless back-office interoperability that Capuano envisions. In the wake of the LCH-Clearnet merger, the LSE this month is going head-to-head with Euronext by launching a trading service in Dutch equities, and Euronext plans to offer trading in British stocks later this year. As a result, many of the biggest players in Europe’s securities markets are hoping that Capuano’s vision of interconnected, competing exchanges becomes a reality.
“The emphasis is changing from mergers,” says Niki Beattie, head of market structure at Merrill Lynch International in London. “We would be happy with multiple competing exchanges. Where we really need to see consolidation is in clearing and settlement” because that’s where the big costs are.
Capuano wants to focus on improving connections between exchanges because he lacks the size to compete head-on with his bigger rivals. The Borsa is a distant fourth among European exchanges. Revenues were E180.2 million ($225.7 million) in 2003, up 21 percent, but just one eighth of Deutsche Börse’s, one fifth of Euronext’s and one half of the LSE’s. The Borsa’s market capitalization of E499 billion compares with E2 trillion at the London Stock Exchange, E1.69 trillion at Euronext and E842 billion at Deutsche Börse, and average daily equity turnover of E3 billion compares with E10.2 billion at the London Stock Exchange, E6.9 billion at Euronext and E4.3 billion at Deutsche Börse.
The Borsa’s financial performance compares favorably with its rivals’. The exchange’s operating profit rose 7 percent last year, to E51.7 million, before goodwill write-offs related to its E245 million purchase of settlement house Monte Titoli in 2002. The operating profit margin was 28.6 percent, roughly in line with Euronext’s 27.6 percent and Deutsche Börse’s 29.8 percent but trailing the LSE’s 34.4 percent. Net profit declined to E19.6 million from E30.4 million a year earlier, but would have risen without the goodwill write-off.
The Borsa also boasts some particular strengths. It is Europe’s third-largest derivatives market; with E693 billion in equity futures and options volume last year, it trailed only the European operations of Deutsche Börse’s Eurex affiliate and Euronext’s London International Financial Futures and Options Exchange. Milan is the world’s second-biggest market in covered warrants. And of the eight high-growth stock segments launched by Western European exchanges in the late 1990s, the Borsa’s Nuovo Mercato is the biggest of the three left standing, with E1.7 billion in monthly trading volume. (The others are Spain’s Nuevo Mercado and Euronext’s Nouveau Marché; Deutsche Börse’s Neuer Markt was among the casualties.)
But Capuano is beginning to feel some competitive pressure. In February, Deutsche Börse launched trading in 12 Italian stock options as part of its effort to develop a truly pan-European market at its Eurex affiliate. So far the initiative is just a cherry-picking exercise, limited to a handful of Italian blue chips, but it could lead to greater inroads.
The Borsa’s CEO remains unruffled. “Deutsche Börse controls the most powerful electronic exchange in the world, and their new derivatives contract sets the competitive bar very high for us,” concedes Capuano, relaxed in his massive, black-marble-trimmed office at the Fascist-era Palazzo Mezzanotte on a recent sunny spring day. “But because of the liquidity and efficiency of our market and our attention to customer service, I don’t think there is a real risk of losing dominance.”
Raffaele Jerusalmi, the Borsa’s executive director in charge of markets, is even more blunt: “Deutsche Börse will end up with zero volume in Italian stock options, and I will put my money on that.”
The Italian executives base their confidence on their trading systems and cost structure. Deutsche Börse has waived transaction fees on its Italian options through May but has not been able to match the Borsa’s tight spreads between buy and sell prices. Although complex fee schedules make it hard to compare Deutsche Börse’s permanent charges with those of Borsa Italiana, they are unlikely to prove lower for most buyers and sellers of Italian stock options. Says Fabrice Evangelista, head of global electronic proprietary trading at BNP Paribas in Paris: “We trade across a wide range of instruments on virtually all of Europe’s cash and derivatives markets. It’s safe to say that overall, no one charges less than Borsa Italiana.”
For all of the Borsa’s strengths, however, it’s by no means certain that Capuano can succeed in maintaining its independence. Competition has never been so feverish. Banks, brokerages and investment managers worldwide are aggressively trying to lower their transaction costs. Many market observers assert that Europe needs no more than two or three exchanges. And Frankfurt’s Deutsche Börse, Paris-based Euronext and the LSE have all done IPOs in the past four years, giving them the resources to force consolidation.
Although none of the Big Three has made a formal takeover proposal, Deutsche Börse and Euronext have acknowledged that they would be interested in acquiring the Milan bourse, Spain’s Bolsa y Mercados Españoles or Zurich’s SWX Swiss Exchange. The Borsa, because it is the biggest in the second-tier and has invested heavily in back-office efficiencies, is seen as a favored target. “The LSE, Deutsche Börse and Euronext talk to us all the time and are all interested in a strong partnership or even a merger with Borsa Italiana,” says Capuano.
Some members of Capuano’s own brokerage community believe the Borsa should take advantage of that interest now. Michele Calzolari, chief executive of Milan brokerage Centrosim and chairman of the Italian Association of Financial Intermediaries, which represents the country’s brokerages, praises Capuano for “protecting the interests of the Italian financial community by developing the Borsa and remaining independent.” But Calzolari says the time is ripe to strike a deal, so that the Italians can negotiate from a position of strength. “To avoid seeing both the influence of the Borsa and the wider Italian financial community marginalized, a merger with one of Europe’s Big Three should be negotiated sooner rather than later,” the broker asserts.
So far, however, Capuano is determined to rebuff his would-be suitors. “We clearly have the means to survive and even thrive as an independent exchange,” he declares. As long as he can make the Borsa’s core operations unassailably world-class, he says, no outsider can easily overrun the Italian exchange’s advantage as the natural home for the domestic institutions that provide the bulk of liquidity. “Trying to compete against domestic markets, no matter how efficient your organization might be, is very difficult, if not impossible, and not the best way to serve the interests of either clients or owners,” he says.
Crucially, Capuano has solid support from the tightly held exchange’s core shareholders. Italy’s six largest banks -- Banca Intesa, UniCredito Italiano, Sanpaolo IMI, Capitalia, Banca Monte dei Paschi di Siena and Banca Nazionale del Lavoro -- together control 52 percent of the Borsa. It’s hardly surprising that they endorse Capuano’s vision. An independent Borsa should help the banks maintain control of merger advisory and underwriting business for Italian companies and custody business for Italian investors. And the banks themselves have been shielded from potential foreign predators by the protective oversight of the Bank of Italy, which wants to keep the country’s financial infrastructure in Italian hands.
“In the long run, as rules and technology in Europe become standardized, mergers will make sense,” allows Pietro Modiano, head of the corporate banking division at UniCredito and a board member of Borsa Italiana, of which his bank holds an 11.9 percent stake. “But the shareholders of Borsa Italiana back Massimo Capuano and believe we should take the time now to further develop Italian financial markets independently.”
Octavio Marenzi, founder and managing director of Boston-based consulting and research firm Celent Communications, who regards exchange consolidation as inevitable, acknowledges that Capuano has put the Borsa in a strong position to decide its own fate. “It may well prove to be the best-positioned second-tier exchange in Europe when it comes to dictating the terms of its consolidation into a pan-European network,” Marenzi says.
THE TALL, COURTLY CAPUANO HAS COME TO PER-sonify an institution that has been in constant transition since the 1990s brought a series of regulatory reforms and the introduction of electronic trading technologies.
A Palermo native who now claims fealty to the Inter Milan football club, Capuano, 49, arrived at the Borsa via the information technology route: After earning an engineering degree from University of Rome La Sapienza in 1979, he spent a year in the after-sales services department of copy machine maker Rank Xerox, then six years with IBM Corp. in Milan overseeing the sales and design of custom IT systems for big banks and insurers.
In 1986 McKinsey hired Capuano to lead its effort to provide technology consulting to financial institutions. Six years later he rose to head of McKinsey’s Milan office, where he became an adviser to the CEOs of most of Italy’s major banks. The government hired McKinsey to advise on the privatization of Borsa di Milano, which was sold to Italian banks and brokerages in an auction in September 1997. Four months later the Borsa’s new controlling shareholders, Italy’s largest banks, tapped Capuano to become the first CEO of the rechristened Borsa Italiana.
By then the 190-year-old Milan exchange had already made considerable operational strides. In 1991 nine small regional exchanges had been merged into the Borsa; that same year it had launched the Mercato Telematico Azionario equities-trading platform, reducing costs and attracting liquidity. Before that, 60 to 70 percent of Italian stock trading occurred in banks’ dealing rooms or on the SEAQ International exchange in London. Today virtually all Italian shares are traded through the Borsa’s MTA. In 1994, under Capuano’s predecessor at the Borsa di Milano, Attilio Ventura, floor trading had been abolished and the Italian Derivatives Exchange Market had been established. By the time Capuano took over at Borsa Italiana, daily equity trading had risen to more than E1 billion, compared with less than E200 million in 1990. Volume has risen nearly threefold since then.
“Much was accomplished in the 1990s, but rules were still being set by the government,” recalls Capuano. “We clearly needed to make this a more entrepreneurial exchange that was both more efficient and more responsive to the needs of companies and users, which is why it was privatized.”
Capuano inaugurated the Nuovo Mercato in May 1999, and a year later the settlement cycle on Italian stock trades was shortened from five days past the trade to three days, or T+3, in line with the U.S. and most other developed-country markets. He then took further steps to complete the blueprint he had drafted at McKinsey: In April 2000 the Borsa purchased a controlling interest in clearinghouse Cassa di Compensazione e Garanzia, and in December 2002 it acquired the country’s central securities depository, Monte Titoli. In 2003 the Borsa invested E16 million in a new clearing and settlement system.
But weaknesses remain -- first and foremost, the Borsa’s share listings business. Despite attempts to lure more of Italy’s many family-owned companies, the equities market has only 279 listings, for a net gain of nine since Capuano became CEO in 1998. That compares unfavorably with not only the Big Three -- the LSE has 2,673 companies, Euronext 1,033 and Deutsche Börse 861 -- but also with the SWX Swiss Exchange’s 419 listings and the Spanish Bolsa’s more than 2,000 (although only one fourth trade with any frequency).
Capuano has identified more than 1,200 small and midsize private companies with the kind of healthy sales and profits that would make listed shares attractive to investors. He has even created special sectors to attract them, including the 43-stock Nuovo Mercato for growth companies and the 42-stock STAR segment for companies that meet tighter corporate governance standards, such as having at least two independent directors, an internal audit committee with a majority of independent directors and a minimum float of 35 percent. But it has been tough going. The Borsa lost listings during the bear market, when many public companies went private, and even though the climate improved last year, only four companies launched IPOs, the lowest number since 1998. (Six IPOs are currently in the pipeline for 2004.)
“Italy is a country of entrepreneurs who rely heavily on traditional bank loans to finance growth,” notes the Borsa’s Jerusalmi. “That connection has to be broken before we will see a big uptick in listed companies.” Says UniCredito’s Modano, the big Italian banks are trying to do their part “by encouraging everything from securitizations to listings.”
What could be a better example of capital-raising than Borsa Italiana itself?
“All the main players have publicly quoted stock, which provides them with important resources for development and growth,” notes Capuano. “If we don’t want to fall behind, then we will need those same resources. Not being listed could in the long run be more dangerous than being listed when it comes to our ability to continue as a stand-alone company.”
Prospects for a listing have been delayed, however, by political infighting surrounding legislation to clean up Italy’s financial system in the wake of the Parmalat accounting scandal. Economy and Finance Minister Giulio Tremonti and Bank of Italy governor Antonio Fazio are engaged in a power struggle over the creation of a new superregulatory agency for financial services, which Tremonti believes should diminish the central bank’s oversight duties. Parliament is due to consider that legislation this summer. Only when they have finished that business can lawmakers turn their attention to enabling legislation for a Borsa IPO. “We are still optimistic we can see such a law passed by the end of the year, making a stock market offering in 2005 possible,” says one senior exchange executive.
Giorgio La Malfa, chairman of the Chamber of Deputies’ finance committee, favors an IPO and believes it will enhance the Borsa’s ability to compete and remain independent. As for the possibility of a takeover by a larger exchange once the Borsa is listed, La Malfa says, “We have to accept the rules of the game, but that doesn’t mean there couldn’t be a shareholder pact that insured the Borsa’s independence.”
ALTHOUGH HE IS RESISTING BLANDISHMENTS TO join forces with his bigger rivals, Capuano has been sizing up the competition ever since he took the helm at Borsa Italiana.
In mid-1998, while he and other European exchange leaders were exploring ways to facilitate pan-European trading, the London Stock Exchange and Deutsche Börse announced plans to launch a common trading platform for Europe’s 300 largest issues. The alliance threatened to decimate listing demand and trading volumes in Milan and other regional centers, so in November 1998, after considerable hue and cry, London, Frankfurt and seven other exchanges -- Amsterdam, Brussels, Madrid, Milan, Paris, Stockholm and Zurich -- agreed to negotiate a broader merger. That effort ended a year later when ParisBourse CEO Jean-François Théodore, fearing British-German dominance, joined forces with the chiefs of the Amsterdam and Brussels exchanges to form Euronext. Meanwhile, the Deutsche BörseLSE plans fell apart when the two sides couldn’t agree on how shares would be allocated and whether clearing would take place in London or Frankfurt.
“Nothing could have suited Capuano more than the breakdown of the London-Frankfurt merger and the creation in Europe of a big league of three major securities exchanges,” says a senior Borsa executive. Having three competing power centers in Europe made it unlikely that any one exchange would siphon significant liquidity away from a strong second-tier operation like Borsa Italiana.
Capuano opposed any kind of merger that would marginalize bourses like his, but he favored standards that would make exchange operations compatible, or interoperable, with one another. “We always thought it would be easier to establish a network linking the exchanges,” rather than building a single trading or settlement platform, he explains.
The interoperable approach is evident in the Borsa’s single central counterparty, or CCP, set up in May 2003, and its state-of-the-art Express II settlement system, which the exchange finished putting in place in January. For the first time, the Borsa has a clearing and settlement system that can net out trading positions across equities, derivatives and bonds. Although fees have risen an estimated 20 to 30 percent to cover the cost of the technology, having a single CCP should reduce the total costs and settlement risks of brokers and investors.
From an interoperability standpoint, Express II and the central counterparty are Capuano’s gateway to the world. Analysts rate the systems as the most flexible in Europe in terms of permitting cheap, efficient links with other clearing and settlement organizations. A link between the CCPs operated by the Borsa and Paris-based Clearnet, the Euronext-allied operation that recently merged with the London Clearing House, permits users to choose where they want to clear and settle trades, ending the necessity and added expense of belonging to both organizations. The Borsa-Clearnet link now covers bonds, but Capuano says it will be expanded to stocks and other instruments if clients demand it. Borsa executives hope to establish similar ties with the clearing and settlement arms of Spain’s Bolsa and Switzerland’s SWX and with Deutsche Börse’s Eurex Clearing subsidiary, although the Germans so far have been cool to the idea of interoperability.
Werner Frey, head of the European Securities Forum, a lobbying group that represents many of the biggest investment banks, endorses Capuano’s vision. “For users, there is no need to go through the complication and added expense of connecting directly to a range of different exchanges if there is the option of interoperability,” he says. “Given that Borsa Italiana has a fully interoperable system now, there will be less pressure on them to merge with one of the bigger exchanges even if we see a new consolidation wave in Europe.”
The Borsa’s capabilities demonstrate the advantages of its interoperable strategy, asserts Giovanni Sabatini, CEO of the Borsa’s settlement arm, Monte Titoli. Unlike the Borsa’s technology, LCH.Clearnet will keep the existing central counterparties of LCH and Clearnet separate until it merges their technology platforms in 2007. “LCH and Clearnet are saying that integration of the technical processes should start with the merger of the companies,” says Sabatini. “That’s not what we believe. Cost reduction benefits for the customer will come only from the integration of the processes, not from the merger of the companies.”
UniCredito’s Modiano suggests that Capuano has built an exchange that will likely survive in some form, even if under a foreign umbrella. “If one day there is a real case for further mergers between regional and national exchanges in Europe, then we might see the Borsa specialize, running a platform for the kind of small and midsize companies that dominate our economy but that are still underrepresented on our stock exchange,” he says.
But Capuano isn’t ready to consider such scenarios, and, according to one prominent Italian investment banker, he has staked out a strong tactical position. Even if the Borsa’s majority owners get a hostile takeover bid of 30 to 40 percent above the value of their shares, says the banker, “that’s still unattractive to banks, compared with the potentially huge loss in operating profit that would accompany the migration of trading in Italian shares to another exchange.”
Indeed, Capuano says that, given the welter of rules, regulations, tax codes and IT systems that cross-border exchanges must navigate, a merger would only raise costs and complications without providing compensating synergies. “That situation may evolve with time, especially as Europe’s governments harmonize laws and regulations, but today we want to control our market,” he says. Some European Union officials optimistically predict that that long-delayed harmonization will be completed by 2006, but Capuano believes that it will take considerably longer. He’s designed Borsa Italiana for the duration.
