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Deal or No Deal?

07 Apr 2011

Professor Alex Frino looks at the major financial implications of a failed merger proposal between the Australian Stock Exchange (ASX) and the Singapore Stock Exchange (SGX).

It appears that the Foreign Investment Review Board and the Federal Treasurer are poised to reject the proposed merger between the Australian Stock Exchange (ASX) and the Singapore Stock Exchange (SGX) because it is not in our national interests. While the reasons for the decision have not been articulated and may never be articulated, it is perhaps worthwhile re-examining why the deal is in the national interest.

For some time now, the Australian government has harboured ambitions of being a regional financial centre. This ambition comes out of the realisation that we are one of the largest capital markets in the world and generate a very large portion of GDP in the Australian financial services sector (particularly in NSW). However, we export less than 1 percent of our financial services abroad. Consequently, we are missing out on economic growth that could come from financial services export. We have built the capacity and capability of being a regional financial centre transacting international business in our marketplace, but unfortunately, that potential has not been realised.

An aspiration of becoming a regional financial centre requires the Australian market to embrace international investment and international order flow. SGX and ASX are similar in many regards, particularly in terms of their size and how they run their operations. However, they differ in one important respect; the quantity of international capital that they attract. Singapore has carved out its success and learned to "punch beyond its weight" (to quote an oft used term) by focussing on attracting international order flow. Take for example the Nikkei Stock Index futures contract. They were the first exchange in the world to list the Japanese contract. Furthermore, long after the Japanese decided to list the contract and remains very actively traded. The reasons for this is that SGX has been very effective at tapping international order flow. So while the Japanese contract and market attracted Japanese investment, the Singaporeans remained a viable value proposition by maximising the efficiency of their market and thereby tapping international capital. In contrast, the Australian market has not done the same. Perhaps its because compulsory superannuation has driven the creation of the 4th largest pension market in the world. Whatever the reason, the Australian equities market is a domestic market dominated by domestic listings and order flow sourced from domestic investors. This has driven some ASX companies to list offshore, companies like BHP and Rio Tinto and also driven others to bypass Australian markets altogether and list offshore. Hence, one of the main benefits… the national benefit… of the merger would be to allow ASX to tap SGX's global capital reach. This is not only good for Australian markets, but also good for our aspirations as a regional financial centre.

There is another important point worth making. The transaction involves the merger of the operations of the ASX and SGX. That is, a merger of IT infrastructure, people, office space etc. This is likely to yield cost efficiencies which can be passed on to corporations seeking equity capital through a lower cost of transacting and therefore a lower cost of capital - another national benefit. But this is not the main point. The merger does not involve the integration of regulatory oversight. Australian savings and capital will continue to be regulated and therefore protected by APRA and ASIC. In a similar way, Singaporeans savings and capital will continue to be regulated and protected by the Monetary Authority of Singapore. Analogously, Australian companies (who run the nations productive capacity) will continue to be regulated by ASIC. The deal proposes merging operations, but not merging regulatory oversight. Regulatory sovereignty will be maintained. Therefore, the protection of our savings and productive capacity is retained: there can be no diminuition in the national interest from this source.

Let me return to the main question. Apart from missing out on the national benefits of such a merger, what happens tomorrow if the decision is "no deal". Unfortunately, another suitor is unlikely to emerge. A poorly appreciated fact is that the market value of two of the largest exchanges in the world by the market capitalisation of its listings (ie. the London Stock Exchange and NASDAQ/OMX) is roughly half that of the ASX and SGX. They do not have the balance sheet to mount a bid as attractive as the one on the table for the shareholders of ASX. The largest equities market in the world by its market value is the Hong Kong Stock Exchange. However, the broader global reach of that exchange is not as effective as that of SGX.

We live in a global economy were mergers of smaller exchanges are taking place to create larger critical masses of liquidity. Take for example the current offer by the Deutsche Bourse for another already merged exchange NYSE/Euronext, or the current offer by the London Stock Exchange for the Toronto Stock Exchange, both of which are likely to proceed. A rejection of the ASX/SGX deal sends out a signal that we are unwilling to embrace global equities markets: which is inconsistent with global trends.

So where does that leave us? On our own, with domestic listings, domestic order flow and a declining market presence. It doesn't sound like the makings of a regional financial centre, now does it?

Professor Alex Frino
Discipline of Finance, The University of Sydney Business School
Chief Executive, Capital Markets Cooperative Research Centre