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WFE Focus April 2011
Interview with WFE Chairman, Ronald Arculli on exchange industry Mariana Segala of Brazil’s Brasil Econõmico newspaper, 13 May 2011

Q: What is your view about these moments in which so many exchanges are leading a consolidation movement?

A: The proliferation of alternative trading platforms bypassing exchanges is creating fragmented market structure and eroding market share of many of the traditional regulated exchanges.  Hence, some exchanges are seeking to merge in their quest for strategic flexibility and synergy. Others may be contemplating such moves in order to assure that their clients – issuers and investors – are well positioned to benefit from the continual increase in cross-border financial business.

Q: What kind of changes the M&A activity may bring to the exchanges markets?

A: It may lead to more competition among exchanges as larger groups seek to take advantage of their economies of scale and expand. And beyond the competition point, there is a sense of development of new services that the exchanges – the market-neutral actors – are well placed to provide to bolster the crucial businesses of capital raising and risk lay-off.

Q: Is there any kind of recommendation made by WFE to the exchanges about that? Is the federation concerned about that?

A: The WFE does not have a position on exchange M&A per se, that is very much a matter for each member which might be involved. But the WFE is a firm believer that there should be a level playing field between exchanges and other entities performing some of the same or similar functions, and this is clearly not the case in the North Atlantic jurisdictions where a false competition has been set loose by the public authorities. 
Q: What should be the consequences of the movement for the market participants (public companies,
investors and brokers)?

A: There have been several mergers in recent years and their impact on most market participants has been relatively minor. It is to be hoped the appropriate authorities, either regulators or lawmakers, would take action if there were signs in the future that mergers were having a negative impact on market participants. Somewhat to the contrary of the sense of this question, one of the drivers behind the exchange merger movement has been to facilitate access of market participants to more exchanges, in order that they can more easily expand their businesses.

Q: If the developed countries’ exchanges merge, what should be the emerging countries’ exchanges (like BM&FBOVESPA here in Brazil or HKEx) new role?

A: M&A activity will not change the fundamental role of exchanges. Capital raising and secondary-market pricing remain the key function for the securities and securities options segments, while standardised contracts for financial and raw materials products on futures markets provide essential pricing indicators for the world’s economy and risk lay-off. Whatever the form of the regulated exchange, it is in these two complex fields that its business purposes are realized.

Q: And what about the WFE new role (if there is one)? Will the consolidation movement require new regulatory discussion?

A: The WFE is the trade association of 52 publicly regulated stock, futures and options exchanges and we think its important role will remain the same.

The WFE promotes regulated exchanges in four ways: Quality, by promoting high global market standards and reliable statistics; Advocacy, by working with policy makers, regulators and government organisations for fair, transparent and efficient markets; Networking, by bringing together exchange experts to improve markets; and Development, by helping newer, smaller exchanges to meet WFE standards.

It is important to note that the regulated exchange idea continues to burgeon across the world. The transparent marketplace and fair pricing of these assets is considered a public good by a great variety of governments and societies all across the world. Its value to all was proven by the point that exchanges were a very rare private sector financial institution that continued business very nearly normally in extremely difficult circumstances post-2007. And they did so without government backing or guarantees – because the model works!

Q: We’ve been facing a reduction of traded volumes in a lot of countries markets. What are, in your opinion, the new challenges with which the exchanges may deal in the next years?

A: The WFE has expressed concern in two areas. One is the absence of a level playing field among exchanges and other providers of trading facilities in those jurisdictions where governments were persuaded that competition in any form was a good thing for efficiency – even unfair competition, in fact. The damage done shows up in the loss of transparency and fairness each day, and in its most extreme form it showed up in the US “flash crash” of May 2010.

Reduced market transparency occurs when stock trading becomes fragmented. Fragmentation makes it harder for investors to find liquidity; regulators are concerned that fragmentation does indeed make it harder for them to conduct effective market surveillance against potential market manipulation and abuse; and listed companies fear seeing their shares trade at prices that do not reflect the value of their companies due to technical reasons about order routing that are hard to explain by anyone, since the overall view of the marketplace has been lost.

In addition, the WFE has called for the proven benefits and safeguards of exchange trading to be factored into any new regulatory frameworks.

Q: What have been, in your opinion, the main regulatory changes that exchanges have seen recently (since the 2008 crises)?

A: It should first be stated that the WFE Board of Directors and Secretariat went into market policy “overdrive” as from mid-2007 as credit markets were drying up, because that already was having a severe effect on our trading activity. One learns a lot by price formation in a regulated marketplace, the indicators of problems were there to see in cash and derivatives trading.

One major change that comes to mind is the ongoing effort towards increased central clearing of OTC derivatives, which is designed to improve market transparency and risk management, and give regulators the information they need to do their jobs. Exchanges and their associated trading houses have been clear to say that only those instruments which lend themselves to standardization and good valuation for adequate margining would be able to be transferred to the infrastructure facilities they provide. Otherwise, OTC should stay off-exchange, and it is for those banks writing those contracts to prove their economic value to their clients.

Q: What do you and the federation think of high frequency trading? Are you planning to develop any kind of recommendation for the associated exchanges?

A: The WFE is certainly very aware of the increasing role of high frequency trading in some markets. It is an important issue and one that needs to be studied further to gain a good understanding of high frequency trading’s impact on markets and market participants, and especially in the fairness issues they imply. One of the strengths of the regulated exchange environment has been transparent price discovery, with visibility of the bid and offer prices shown in the central order book, so that’s one area to considering when examining the impact of high frequency trading.  I would expect that if exchanges keep that goal in mind, the marketplace will be well served. Exchanges have adapted to all kinds of new technologies over the centuries, and in the case of HFT the fundamental principles of fairness should see us through once again.

In closing, as WFE chairman, I would wish to congratulate Maria Helena Santana, President of Brazil’s CVM, on her nomination as chairman of the IOSCO Executive Committee at last month’s annual conference of the world’s capital markets regulatory agencies. WFE knows her views on the crucial point of market integrity, and very much looks forward to working with her in this new capacity.

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