A l'Est, Du Nouveau

This blog post was originally published by the Financial Times.

It is impossible to discuss the financial markets of central and eastern Europe without highlighting the accomplishments of the Warsaw Stock Exchange. The recent adrenaline rush among the CEE’s other exchanges, desperate to transform themselves into serious players, can only be understood in the context of the WSE’s success in positioning itself as a regional champion.

While 2011 was a difficult year for financial markets globally, the WSE managed to attract 47 per cent of the total European IPO market to Poland, with 203 companies listing on the two stock markets operated by the WSE in the year, up from 112 in 2010.

And it wasn’t just Polish businesses joining the Warsaw bourse. Companies like Bulgaria’s Sopharma helped swell the ranks, taking the total capital raised to €2.2bn, according to PwC’s January IPO Watch.

With a new low-latency trading platform from NYSE-Euronext due to go live this year and an expanding range of investment instruments, Warsaw has been advancing its claims for a seat at the top table of global exchanges.

But the real fuel for the increasing attractiveness of Poland to international investors and companies has been the country’s solid economic growth through the global crisis, with a 4.2 per cent increase in GDP last year.

In Russia, events in the financial markets have unfurled at a rapid pace, spurred by the government’s decision to promote Moscow as an international financial centre. Following a merger between the local exchanges in 2011 – one of the few exchange deals that succeeded during a year of attempted tie-ups – the newly-unified MICEX/RTS group plans to play a regional role in CEE.

It’s still early days (the merger was only finalized in December) but Russia’s intentions are serious, with an aggressive timetable for transforming almost everything: trading platforms, the clearing and settlement process, the depository structure, and connectivity.

Just as importantly, perhaps, MICEX/RTS is looking to reclaim liquidity lost to foreign exchanges: Gazprom and Lukoil, for example, are among the most heavily-traded stocks on the London Stock Exchange.

With the WSE listing companies from Russia’s “natural” hinterland such as the Ukraine, it is no surprise the Russian exchanges are looking to regain the initiative. A crucial task for the Russian authorities remains to ‘westernise’ the structure of their capital markets to give international investors the common experience they seek in doing business overseas.

More broadly, the Russian authorities will need to underpin their willingness to create deep capital markets in Moscow with tough reforms, enshrining the independence of the judiciary and the rule of law and progressively limiting state intervention.

At the same time, central to regaining the initiative will be marketing recently-acquired Russian financial know-how, and promoting access to an increasing pool of liquidity to countries considered to be within the Russian “sphere of influence.” From Mongolia to the Stans, Moscow will be working hard to capture new listings and new traders.

MICEX/RTS won’t have an easy ride in CEE. Aside from the WSE, there will be competition from the Central and Eastern Europe Stock Exchange Group (CEESEG), made up of bourses in Vienna, Budapest, Prague and Ljubljana, formed in January 2010.

The unification of these exchanges under Vienna’s leadership can be seen as a direct response to the rise of the WSE. Home to 248 listed companies, worth €128.5bn, the CEESEG compares favourably to the WSE’s overall market cap of €125.8bn, though the latter counts more companies among its number – nearly 800.

A common trading platform, Deutsche Boerse’s Xetra, is one essential piece in the CEESEG’s strategic jigsaw. Vienna has been using the system since 1999, Ljubljana came on board in 2010 and Prague and Budapest will follow in 2012/2013. The CEESEG will soon look like one exchange with considerable listing and trading benefits from the resultant combined liquidity, with common data vending and joint index licensing already a reality.

Other stock exchanges in the region, especially in south eastern Europe (SEE), should start considering how to best serve their local economies and how to benefit from the momentum created by the initiatives under way in the wider CEE region. Economic growth continues, albeit subdued by the crisis to the west, and there are plans for European Union integration and even possible adoption of the euro. While many SEE markets are still small, each country has exchanges that can act as national champions.

One can foresee SEE capital markets rearranging along new lines over the next couple of years, with further rationalisation of stock exchanges. There are three ways this could happen: Firstly, go it alone – a complicated and unconvincing tactic. Secondly, form an alliance – and follow the example of the CEESEG members. This could be a tactic for exchanges such as Romania, Bulgaria, Croatia. We could see one or two new regional alliances created or even CEESEG adding new markets to its own alliance.

Thirdly, straight-forward regional acquisitions – the WSE or MICEX/RTS must be seen as strong potential suitors in SEE. IMKB, the Turkish Exchange, could provide competition, having recently expanded its interest (and investment monies) beyond the Turkish borders and back into old “Ottoman Europe.”

Meanwhile, established exchange groups like the acquisition-hungry LSE, NASDAQ OMX, NYSE Euronext or Deutsche Boerse, may begin to look CEE trading and clearing with greater interest. Deutsche Boerse already supplies its trading platform to many exchanges in the region (CEESEG), so it has an interest in these markets, as so do NYSE Euronext (WSE) and NASDAQ OMX (Baltic Exchanges); it would be natural for all of them to seek to extend these relationships.

In the near term, with the recent failure of high-profile bourse mergers, developed market exchanges that either want to expand their global influence or take a piece of the growing CEE pie seem likely to look towards strategic partnerships, rather than out-and-out M&A. With all the energy and money that’s been spent on failed tie-ups recently, who can blame them?