- Email: [email protected]
An overview of the conference sessions
Journal of Banking & Finance 27 (2003) 1605–1609 www.elsevier.com/locate/econbase
Editorial
An overview of the conference sessions
As venues for trading financial securities consolidate at an accelerating pace and the search for capital increasingly becomes a global activity, national and regional securities exchanges face the daunting task of maintaining their existing market share while responding to the realities of global capital market realignment. Compounding this push to consolidation are unprecedented technological, service, and financial pressures within the financial securities industry. In order to improve their ability to respond to competitive pressures, many exchanges are transforming themselves into for-profit businesses, with the goal of becoming publicly listed companies in their own right. Some exchanges have already become publicly listed companies. Customer service (for both existing and new services) is becoming crucial, with increasing competition between and among exchanges for listings and for order flow. Simultaneously, electronic alternative trading systems are pressuring traditional exchangesÕ pricing and offering alternate pools of liquidity for many equities. Against this background, the University of Toronto Capital Markets Institute held a conference in Toronto on August 16 and 17, 2002 at the Rotman School of Management aimed at assessing the Future of Stock Exchanges in a Globalizing World. Over 60 practitioners and academics addressed these issues. This article briefly summarizes the papers presented at the conference. In addition to the academic papers and discussant comments contained in this volume of the Journal of Banking and Finance, a practitioner panel produced a lively discussion. Ian Domowitz (Managing Director, ITG, Inc.) presented the ConferenceÕs keynote speech, anticipating many issues that would re-appear during the remainder of the Conference. The unifying theme of DomowitzÕs talk was that automation has had and will continue to have significant effects on exchanges, brokers, and investors. In an electronic world, it is cheaper and easier for new liquidity sources to appear. Investors increasingly will demand that exchanges and brokers provide low-cost access to these liquidity pools (particularly with regard to price impact costs), which will bring value-added methods of intermediation to the forefront. Domowitz went on to discuss some of the products offered by ITG, Inc. One service that exchanges can provide in a globalized world is cross-listing. To the extent that cross-listing integrates markets, provides access to additional sources of equity capital, adds liquidity to the trading of a firmÕs stock, increases 0378-4266/$ - see front matter Ó 2003 Elsevier B.V. All rights reserved. doi:10.1016/S0378-4266(03)00090-6
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Editorial / Journal of Banking & Finance 27 (2003) 1605–1609
the recognition of the listing firm, and/or bonds the firm for minority shareholders, then cross-listing might add value for the listing firmÕs shareholders. Two papers in this issue address whether these potential sources of value appear to be available to non-US firms listing in the US. Errunza and Miller (2003) ask whether non-US firms can reduce the agency cost typically associated with issuing equity by using the US market to raise capital. In contrast to much of the previous cross-listing literature, they focus on seasoned US equity offerings of non-US firms. This focus permits a separation of the effect of raising capital from the effect of capital market integration; the latter effect is associated with the initial cross-listing. Errunza and Miller find that when cross-listed firms announce the issuance of seasoned ADRs to raise capital in the US the effect on equity prices is economically and statistically insignificant. This stands in stark contrast to empirical evidence that US firms typically lose 2–3% of market value on the announcement date of a new equity issue. Furthermore, a control sample of non-US firms raising capital only in their home market during the sample period experiences an average return that is 1.5% less than the sample firms using the US market to raise capital. Finally, Errunza and Miller find that the announcement date return is significantly positively associated with the fraction of capital being raised in the US. Their results suggest that cross-listed non-US firms can raise capital more cheaply than their non-cross-listed competitors. Mittoo (2003) documents the benefits to Canadian firms choosing to list in the US during the decade of the 1990s and compares those benefits to the benefits documented by other researchers in previous decades. She argues that the increased integration of global capital markets during the 1980s and 1990s decreased the strength of one of the traditional benefits of cross-listing––cheaper capital availability in the US. The increased pace of cross-listings, however, suggests that firms find other benefits to being listed in the US. She finds a smaller price run-up prior to cross-listing and smaller cross-listing effects on price and liquidity in the 1990s than in the 1980s. MittooÕs examination of long-run returns questions the value of US cross-listing for Canadian firms in general and resource firms in particular. The lower long-run returns to cross-listed firms, however, are consistent with a lower cost of capital for cross-listed firms. Two of DomowitzÕs themes were the importance of trading costs in an exchangeÕs survival and the move by stock exchanges to become more like other businesses. These themes were evident in the two sessions on Friday afternoon. A recurring tension in market design is whether investors are better off with order flow concentrated on a single venue to pool the liquidity or fragmented across several venues to increase competition. As the market for financial security trading goes through the cycle of adding competitors and then consolidating, order flow naturally fragments and consolidates. Does this cycle seem to affect the quality of the security markets? Boehmer and Boehmer (2003) examine the effects of the New York Stock ExchangeÕs entry into the Exchange Traded Fund (ETF) arena on measures of market quality. This represents the first (and to date, only) instance of the NYSE trading securities not listed on its exchange. Prior to the NYSEÕs entrance to the ETF mar-
Editorial / Journal of Banking & Finance 27 (2003) 1605–1609
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ket, these securities traded only on the American Stock Exchange, regional stock exchanges, and Nasdaq. They find that NYSE competition is accompanied by substantial increases in liquidity (measured by quoted depth and the price impact of a trade) and decreases in trading costs overall and in the individual markets that traded these securities prior to the NYSEÕs entry. Quoted and effective spreads experience doubledigit percentage decreases and quoted depth increases by at least 50%. After addressing other potential explanations, Boehmer and Boehmer conclude that additional competition eliminates market-making rents. They interpret this as suggesting that market fragmentation need not harm investors. Kam, Panchapagesan, and Weaver (2003) study changes in trading costs surrounding the New York Stock ExchangeÕs decision to eliminate its prohibition against its membersÕ trading certain NYSE-listed securities outside of an exchange environment––NYSE Rule 390. This rule applied to all securities listed on the NYSE between its founding and April 1979, when the Securities and Exchange Commission forced the NYSE to drop this restriction for new listings. Kam, Panchapagesan, and Weaver find no substantive change in overall trading costs as measured by the effective spread (suggesting that the prohibition might not have been binding). They do, however, identify one apparent strategic response by NYSE market participants that was designed to compete in the new environment and that resulted in improved market quality. Specifically, they find that the NYSE quoted spread decreases and the NYSE quoted depth increases. This response is consistent with the NYSE specialist competing with venues that merely match the NYSEÕs quoted prices when executing trades. The strategy apparently is effective with the NYSE losing little market share as a result of eliminating Rule 390. Naes and Skjeltorp (2003) provide additional evidence regarding the rapidly expanding trading venues known as crossing networks. A crossing network attempts to match a customer order on one side of the market with a customer order on the other side of the market. The trade, should there be a match, typically occurs at the quoted spreadÕs midpoint, reducing the tradersÕ execution costs. It is possible, however, that there is no one on the other side of the market at the time a trader wishes to execute an order, forcing that trader to transact at a less favorable price after learning of the failure to cross. After documenting that crossing networks are most likely to trade the most liquid stocks, Naes and Skjeltorp examine the costs associated with the trading strategy of a large institution making extensive use of crossing networks prior to routing orders to the New York Stock Exchange. Specifically, the trader initially submits all orders to a crossing network and re-submits those orders not filling on the crossing network to the NYSE the following trading day. Because they know the entire history of each order (i.e., the date it was initially sent to the crossing network and, if applicable, the date it was re-routed to the NYSE) they can provide an ex ante analysis of the investorÕs trading strategy. Naes and Skjeltorp find that trading costs are lower on the crossing network than on the NYSE. More importantly, they estimate that the trader could not do better submitting the orders directly to the NYSE. However, the benefit of crossing is concentrated in the most liquid stocks, making the generality of their results an issue.
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Editorial / Journal of Banking & Finance 27 (2003) 1605–1609
Another theme raised by Domowitz was the reaction by traditional exchanges to increasing competition posed by alternative trading venues; under this pressure, exchanges are beginning to think of themselves in traditional business-efficiency terms. Hasan et al. (2003) use a panel of data to examine the revenue and cost efficiency of 49 exchanges from around the world in the 1989–1998 period. They find that revenue and cost efficiency measures vary dramatically. North American exchanges are found to be the most efficient, but European exchanges (with their consolidation and push towards automation) are gaining ground. Exchanges in South America and Asia-Pacific appear to be lagging behind. In addition, they document that exchangesÕ investments in automation and technology appear to pay off in increased efficiency. Finally, they find that, on average, exchanges organized as forprofit businesses are more efficient than those that are mutual organizations. The final academic session of the Conference examined the role market structure plays in trading costs. In particular, the papers examined the effect of adding specialist on trading costs, the role that organizational form plays on across-market costs of trading, and the response by competing markets to changing the minimum price variation in one market. Does an exchange specialist add value in the trading of inactive stocks? Nimalendran and Petrella (2003) use a 1997 innovation in the Italian Stock Exchange (ISE) to estimate the importance of the specialist. Generally, the ISE can be thought of as a pure order book market; traders place orders in an electronic limit order book that are matched with opposite-sided orders. Beginning in 1997, however, the ISE allowed companies with thinly traded stock to choose to add a specialist to the pure limit order book to produce a hybrid market. The specialist is required to make a continuous two-sided market in the stock and to periodically produce investment research on the stock. Using several measures, Nimalendran and Petrella find that stocks electing to switch to a hybrid market enjoy improved market quality after the change. Specifically, they document lower trading costs, greater depth, and less adverse selection after the change in market structure. Fangjian et al. (2003) emphasize the importance of corporate governance for exchanges. Specifically, they compare the performance of the mutual Bombay Stock Exchange to that of the for-profit National Stock Exchange. Although it is difficult to hold everything else constant, the two exchanges follow nearly identical trading processes, trade almost exactly the same stock list, and trade during the same business hours. They find that the for-profit National Exchange appears to be more responsive to investorsÕ interests and more willing to make the investments in automation required to be competitive in todayÕs trading environment, thereby garnering a substantial share of listing and trading activity. Not coincidentally, they find that the National Exchange offers substantially lower trading costs than the Bombay Stock Exchange. This conclusion holds after controlling for exchange-specific factors. Oppenheimer and Subherwal (2002) examine how market structure changes in one country can affect trading in another country by examining how the market participants in the Toronto Stock Exchange (TSE) responded to decimalization in the US. Their sample includes NYSE- and Nasdaq-listed Canadian firms that also have
Editorial / Journal of Banking & Finance 27 (2003) 1605–1609
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stock trading on the TSE. Not surprisingly, they find lower bid–ask spreads and lower quoted depth in the US after decimalization. One Canadian concern was that lower spreads in the US would attract trading to the US and away from Canada. Although trading volume in the US increased after decimalization, it was not at CanadaÕs expense. TSE volume, particularly in retail-sized trades increased after US decimalization. In addition, Oppenheimer and Subherwal document a competitive response by the TSE; Canadian spreads also fall. The degree of decrease in spreads on the TSE depends on the firmÕs capitalization (directly), the decrease in the US spread (directly), and the ratio between the TSE spread and the US spreads prior to the US going to pennies (inversely). What can we take away from the conference papers and discussion? We conclude that, although there undoubtedly has been a redistribution among and possibly a reduction of intermediariesÕ wealth levels, investors appear to have benefited from the changes. Technology has led to exchange restructuring and competition. Competition induced by changes in exchange policies and regulations has resulted in improved operations and benefits to investors and issuers. Also, providing a hospitable regulatory and governance structure and efficient operations may be a way for exchanges to compete and for smaller exchanges to stem the tide of lost trading and issuers. Paul Halpern Toronto Stock Exchange Chair in Capital Markets and Professor of Finance Rotman School of Management University of Toronto 105 St. George Street Toronto, Ont. Canada M5S 3E6 E-mail address: [email protected] Robert Jennings T. Gregg Judith A. Summerville Professor of Finance Kelley School of Business 1309 E. 10th Street Indiana University Bloomington, IN 47405 USA E-mail address: [email protected]
Editorial
An overview of the conference sessions
As venues for trading financial securities consolidate at an accelerating pace and the search for capital increasingly becomes a global activity, national and regional securities exchanges face the daunting task of maintaining their existing market share while responding to the realities of global capital market realignment. Compounding this push to consolidation are unprecedented technological, service, and financial pressures within the financial securities industry. In order to improve their ability to respond to competitive pressures, many exchanges are transforming themselves into for-profit businesses, with the goal of becoming publicly listed companies in their own right. Some exchanges have already become publicly listed companies. Customer service (for both existing and new services) is becoming crucial, with increasing competition between and among exchanges for listings and for order flow. Simultaneously, electronic alternative trading systems are pressuring traditional exchangesÕ pricing and offering alternate pools of liquidity for many equities. Against this background, the University of Toronto Capital Markets Institute held a conference in Toronto on August 16 and 17, 2002 at the Rotman School of Management aimed at assessing the Future of Stock Exchanges in a Globalizing World. Over 60 practitioners and academics addressed these issues. This article briefly summarizes the papers presented at the conference. In addition to the academic papers and discussant comments contained in this volume of the Journal of Banking and Finance, a practitioner panel produced a lively discussion. Ian Domowitz (Managing Director, ITG, Inc.) presented the ConferenceÕs keynote speech, anticipating many issues that would re-appear during the remainder of the Conference. The unifying theme of DomowitzÕs talk was that automation has had and will continue to have significant effects on exchanges, brokers, and investors. In an electronic world, it is cheaper and easier for new liquidity sources to appear. Investors increasingly will demand that exchanges and brokers provide low-cost access to these liquidity pools (particularly with regard to price impact costs), which will bring value-added methods of intermediation to the forefront. Domowitz went on to discuss some of the products offered by ITG, Inc. One service that exchanges can provide in a globalized world is cross-listing. To the extent that cross-listing integrates markets, provides access to additional sources of equity capital, adds liquidity to the trading of a firmÕs stock, increases 0378-4266/$ - see front matter Ó 2003 Elsevier B.V. All rights reserved. doi:10.1016/S0378-4266(03)00090-6
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Editorial / Journal of Banking & Finance 27 (2003) 1605–1609
the recognition of the listing firm, and/or bonds the firm for minority shareholders, then cross-listing might add value for the listing firmÕs shareholders. Two papers in this issue address whether these potential sources of value appear to be available to non-US firms listing in the US. Errunza and Miller (2003) ask whether non-US firms can reduce the agency cost typically associated with issuing equity by using the US market to raise capital. In contrast to much of the previous cross-listing literature, they focus on seasoned US equity offerings of non-US firms. This focus permits a separation of the effect of raising capital from the effect of capital market integration; the latter effect is associated with the initial cross-listing. Errunza and Miller find that when cross-listed firms announce the issuance of seasoned ADRs to raise capital in the US the effect on equity prices is economically and statistically insignificant. This stands in stark contrast to empirical evidence that US firms typically lose 2–3% of market value on the announcement date of a new equity issue. Furthermore, a control sample of non-US firms raising capital only in their home market during the sample period experiences an average return that is 1.5% less than the sample firms using the US market to raise capital. Finally, Errunza and Miller find that the announcement date return is significantly positively associated with the fraction of capital being raised in the US. Their results suggest that cross-listed non-US firms can raise capital more cheaply than their non-cross-listed competitors. Mittoo (2003) documents the benefits to Canadian firms choosing to list in the US during the decade of the 1990s and compares those benefits to the benefits documented by other researchers in previous decades. She argues that the increased integration of global capital markets during the 1980s and 1990s decreased the strength of one of the traditional benefits of cross-listing––cheaper capital availability in the US. The increased pace of cross-listings, however, suggests that firms find other benefits to being listed in the US. She finds a smaller price run-up prior to cross-listing and smaller cross-listing effects on price and liquidity in the 1990s than in the 1980s. MittooÕs examination of long-run returns questions the value of US cross-listing for Canadian firms in general and resource firms in particular. The lower long-run returns to cross-listed firms, however, are consistent with a lower cost of capital for cross-listed firms. Two of DomowitzÕs themes were the importance of trading costs in an exchangeÕs survival and the move by stock exchanges to become more like other businesses. These themes were evident in the two sessions on Friday afternoon. A recurring tension in market design is whether investors are better off with order flow concentrated on a single venue to pool the liquidity or fragmented across several venues to increase competition. As the market for financial security trading goes through the cycle of adding competitors and then consolidating, order flow naturally fragments and consolidates. Does this cycle seem to affect the quality of the security markets? Boehmer and Boehmer (2003) examine the effects of the New York Stock ExchangeÕs entry into the Exchange Traded Fund (ETF) arena on measures of market quality. This represents the first (and to date, only) instance of the NYSE trading securities not listed on its exchange. Prior to the NYSEÕs entrance to the ETF mar-
Editorial / Journal of Banking & Finance 27 (2003) 1605–1609
1607
ket, these securities traded only on the American Stock Exchange, regional stock exchanges, and Nasdaq. They find that NYSE competition is accompanied by substantial increases in liquidity (measured by quoted depth and the price impact of a trade) and decreases in trading costs overall and in the individual markets that traded these securities prior to the NYSEÕs entry. Quoted and effective spreads experience doubledigit percentage decreases and quoted depth increases by at least 50%. After addressing other potential explanations, Boehmer and Boehmer conclude that additional competition eliminates market-making rents. They interpret this as suggesting that market fragmentation need not harm investors. Kam, Panchapagesan, and Weaver (2003) study changes in trading costs surrounding the New York Stock ExchangeÕs decision to eliminate its prohibition against its membersÕ trading certain NYSE-listed securities outside of an exchange environment––NYSE Rule 390. This rule applied to all securities listed on the NYSE between its founding and April 1979, when the Securities and Exchange Commission forced the NYSE to drop this restriction for new listings. Kam, Panchapagesan, and Weaver find no substantive change in overall trading costs as measured by the effective spread (suggesting that the prohibition might not have been binding). They do, however, identify one apparent strategic response by NYSE market participants that was designed to compete in the new environment and that resulted in improved market quality. Specifically, they find that the NYSE quoted spread decreases and the NYSE quoted depth increases. This response is consistent with the NYSE specialist competing with venues that merely match the NYSEÕs quoted prices when executing trades. The strategy apparently is effective with the NYSE losing little market share as a result of eliminating Rule 390. Naes and Skjeltorp (2003) provide additional evidence regarding the rapidly expanding trading venues known as crossing networks. A crossing network attempts to match a customer order on one side of the market with a customer order on the other side of the market. The trade, should there be a match, typically occurs at the quoted spreadÕs midpoint, reducing the tradersÕ execution costs. It is possible, however, that there is no one on the other side of the market at the time a trader wishes to execute an order, forcing that trader to transact at a less favorable price after learning of the failure to cross. After documenting that crossing networks are most likely to trade the most liquid stocks, Naes and Skjeltorp examine the costs associated with the trading strategy of a large institution making extensive use of crossing networks prior to routing orders to the New York Stock Exchange. Specifically, the trader initially submits all orders to a crossing network and re-submits those orders not filling on the crossing network to the NYSE the following trading day. Because they know the entire history of each order (i.e., the date it was initially sent to the crossing network and, if applicable, the date it was re-routed to the NYSE) they can provide an ex ante analysis of the investorÕs trading strategy. Naes and Skjeltorp find that trading costs are lower on the crossing network than on the NYSE. More importantly, they estimate that the trader could not do better submitting the orders directly to the NYSE. However, the benefit of crossing is concentrated in the most liquid stocks, making the generality of their results an issue.
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Editorial / Journal of Banking & Finance 27 (2003) 1605–1609
Another theme raised by Domowitz was the reaction by traditional exchanges to increasing competition posed by alternative trading venues; under this pressure, exchanges are beginning to think of themselves in traditional business-efficiency terms. Hasan et al. (2003) use a panel of data to examine the revenue and cost efficiency of 49 exchanges from around the world in the 1989–1998 period. They find that revenue and cost efficiency measures vary dramatically. North American exchanges are found to be the most efficient, but European exchanges (with their consolidation and push towards automation) are gaining ground. Exchanges in South America and Asia-Pacific appear to be lagging behind. In addition, they document that exchangesÕ investments in automation and technology appear to pay off in increased efficiency. Finally, they find that, on average, exchanges organized as forprofit businesses are more efficient than those that are mutual organizations. The final academic session of the Conference examined the role market structure plays in trading costs. In particular, the papers examined the effect of adding specialist on trading costs, the role that organizational form plays on across-market costs of trading, and the response by competing markets to changing the minimum price variation in one market. Does an exchange specialist add value in the trading of inactive stocks? Nimalendran and Petrella (2003) use a 1997 innovation in the Italian Stock Exchange (ISE) to estimate the importance of the specialist. Generally, the ISE can be thought of as a pure order book market; traders place orders in an electronic limit order book that are matched with opposite-sided orders. Beginning in 1997, however, the ISE allowed companies with thinly traded stock to choose to add a specialist to the pure limit order book to produce a hybrid market. The specialist is required to make a continuous two-sided market in the stock and to periodically produce investment research on the stock. Using several measures, Nimalendran and Petrella find that stocks electing to switch to a hybrid market enjoy improved market quality after the change. Specifically, they document lower trading costs, greater depth, and less adverse selection after the change in market structure. Fangjian et al. (2003) emphasize the importance of corporate governance for exchanges. Specifically, they compare the performance of the mutual Bombay Stock Exchange to that of the for-profit National Stock Exchange. Although it is difficult to hold everything else constant, the two exchanges follow nearly identical trading processes, trade almost exactly the same stock list, and trade during the same business hours. They find that the for-profit National Exchange appears to be more responsive to investorsÕ interests and more willing to make the investments in automation required to be competitive in todayÕs trading environment, thereby garnering a substantial share of listing and trading activity. Not coincidentally, they find that the National Exchange offers substantially lower trading costs than the Bombay Stock Exchange. This conclusion holds after controlling for exchange-specific factors. Oppenheimer and Subherwal (2002) examine how market structure changes in one country can affect trading in another country by examining how the market participants in the Toronto Stock Exchange (TSE) responded to decimalization in the US. Their sample includes NYSE- and Nasdaq-listed Canadian firms that also have
Editorial / Journal of Banking & Finance 27 (2003) 1605–1609
1609
stock trading on the TSE. Not surprisingly, they find lower bid–ask spreads and lower quoted depth in the US after decimalization. One Canadian concern was that lower spreads in the US would attract trading to the US and away from Canada. Although trading volume in the US increased after decimalization, it was not at CanadaÕs expense. TSE volume, particularly in retail-sized trades increased after US decimalization. In addition, Oppenheimer and Subherwal document a competitive response by the TSE; Canadian spreads also fall. The degree of decrease in spreads on the TSE depends on the firmÕs capitalization (directly), the decrease in the US spread (directly), and the ratio between the TSE spread and the US spreads prior to the US going to pennies (inversely). What can we take away from the conference papers and discussion? We conclude that, although there undoubtedly has been a redistribution among and possibly a reduction of intermediariesÕ wealth levels, investors appear to have benefited from the changes. Technology has led to exchange restructuring and competition. Competition induced by changes in exchange policies and regulations has resulted in improved operations and benefits to investors and issuers. Also, providing a hospitable regulatory and governance structure and efficient operations may be a way for exchanges to compete and for smaller exchanges to stem the tide of lost trading and issuers. Paul Halpern Toronto Stock Exchange Chair in Capital Markets and Professor of Finance Rotman School of Management University of Toronto 105 St. George Street Toronto, Ont. Canada M5S 3E6 E-mail address: [email protected] Robert Jennings T. Gregg Judith A. Summerville Professor of Finance Kelley School of Business 1309 E. 10th Street Indiana University Bloomington, IN 47405 USA E-mail address: [email protected]