The ambitions of the London and Frankfurt stock exchanges to engage in mergers with peers on the other side of the Atlantic (see cover story in June 2011's Banker) have had commentators reaching for the superlatives. But for some issuers, bigger is not necessarily better. Both Frankfurt, and in particular the Alternative Investment Market (AIM) in London, have been significant locations for listings by companies in central and eastern Europe (CEE).
These companies may be relatively large entities by the standards of their home countries, but they will be small or medium-sized enterprises (SMEs) in the context of these giant global exchanges. Investment bankers active in the CEE region are consequently discussing with clients whether a listing in London or Frankfurt is still a good fit. Experience even before the current round of exchange consolidation suggests the answer may be not.
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The largest exchanges are interested in the massive trading volumes on cash equity and derivatives for international blue-chip stocks, rather than as platforms for occasional trades in SMEs. Even on AIM, a market specifically targeted at growth companies rather than blue-chips, investment bankers say CEE companies have sometimes struggled to raise capital increases because the liquidity of the original float was insufficient.
That throws a spotlight on stock markets in the CEE region that are large enough to generate sufficient turnover, but close enough to the local economies to create a loyal investor following. Gerhard Grund, a board member of Raiffeisen Centrobank, the equity capital markets (ECM) business of Raiffeisen Bank International, describes the current round of global exchange consolidation as “the great chance for smaller exchanges across the CEE region”, if they can fill the right niche.
“In London, CEE regional transactions do not attract much attention. It is not just about the technical aspects of an exchange platform, but about the research coverage above all. Companies in the region no longer see it as a way to prominence to list in London or New York,” says Mr Grund.
Warsaw seeks SMEs
The Warsaw Stock Exchange (WSE) has already made a specific bid for that SME business, including companies with a market capitalisation of less than €50m, and its marketing strategy has aimed to build up an international network since 2006. Poland’s place as the largest economy and population among the new EU members, and the high proportion of skilled staff who have some knowledge of Russian, have both helped it to establish a role as a regional equity hub.
Listed companies come from Russia, Ukraine, Estonia, Hungary, the Czech Republic and Slovakia. WSE CEO Ludwik Sobolewski says the bourse has also had enquiries from potential debutantes in countries that are not naturally Poland’s economic hinterland, as far afield as Georgia, Armenia and Israel. And in April 2011, Aerfinance became the first UK-based company to float in Warsaw, after delisting from Frankfurt.
“The SME space is where we can play a very significant role, not only in central and eastern Europe, but in Europe more generally. If I think about the WSE in 10 or 20 years, we have a chance to be thought of as a venue for eastern European markets, but also as something broader, as a place for small caps to go public and build their brand,” says Mr Sobolewski.
Ukraine focus
Ukrainian companies are currently a focus of attention for Warsaw, given the poor conditions for equity issuance in their home market. There are eight separate stock exchanges in Ukraine, which fragments liquidity and largely negates any benefits of a public listing. Between them, the exchanges account for just 20% of total equity trading, with over-the-counter transactions overwhelmingly the norm.
This has left the door open to Warsaw to provide a far better trading environment, and two new listings in May 2011 brought the total number of Ukrainian companies on the WSE to eight, of which seven are on the main market and one is on the small companies NewConnect market. In the same month, the WSE launched the WIG-Ukraine index, initially composed of five stocks, which is the first dedicated index of Ukrainian companies outside of Ukraine itself.
“We do not foresee other national indices at this time, but maybe in the future we will set up a regional index for CEE, but not too early. We will take this decision once we have more serious representation of large CEE companies in Warsaw. We want market capitalisation of at least 50% in these companies in Warsaw because our aim is to create liquidity for trading in Warsaw, not on the local bourses where these companies are from,” says Mr Sobolewski.
The WSE already has brokers from Ukraine as local members of the bourse, as well as from the Czech Republic, Slovakia, Hungary and Bulgaria. Mr Sobolewski says their contribution to turnover on the WSE should grow as more companies list from their countries. In addition, all the major international investment banks are local or remote members, and have played a major part in the large Polish privatisation programme over the past two years.
Vienna's open structure
While Warsaw has a head-start, the Vienna Stock Exchange (VSE) is also a significant player. Its approach is quite different. Warsaw is a national exchange with a centrally controlled approach. Even after its own initial public offering (IPO) in October 2010, the WSA is still 35% owned by the Polish state, which retains 51% of the voting rights.
By contrast, Vienna has adopted a more open, international structure. After the VSE had purchased stakes in several CEE stock exchanges, a reorganisation in January 2010 created the CEE Stock Exchange Group (CEESEG), which is 53% owned by Austrian banks and 47% by issuers on the VSE. CEESEG owns the whole of the VSE, plus 93%, 81% and 50.5% of the bourses in Prague, Ljubljana and Budapest, respectively. In addition, a data vending tie-up allows the exchange to distribute data for several other stock markets, from Romania, Bosnia-Herzegovina, Serbia and Macedonia.
This open-architecture approach has given Vienna an edge in terms of index provision. There are seven regional CEE indices calculated by the VSE and eight individual country indices (including one for Poland), together with six more for Russia, Ukraine and Kazakhstan. Investors can also choose between sector indices drawn from stocks across the CEE, including energy, banking, real estate, telecoms and healthcare.
Warsaw's IPO edge
By contrast, however, the Warsaw Stock Exchange seems to have the edge for catching IPOs at the moment. The WSE has more than 400 listed companies in total, compared with just over 260 across the four CEESEG member exchanges. The WSE’s total market capitalisation of about €220bn eclipses the aggregate for CEESEG, which is about €150bn. Moreover, CEESEG’s activity is split across the four member exchanges. Turnover on the VSE has halved since the start of the financial crisis, and the smallest member of the group, Ljubljana, is dominated by local institutional investors with mostly buy-and-hold activity. As a result, annual turnover is less than €1bn.
In this context, Czech energy giant CEZ is dual-listed in Prague and Warsaw, rather than Vienna, and the WSE also listed its first Slovenian company in May this year. Michael Buhl, the CEO of CEESEG and the VSE, says there has been some leakage of potential issuers to Warsaw, but emphasises that Vienna is not aiming to compete to list as many companies as possible. In the case of Ukraine in particular, he says many companies considering IPOs would need to work on their disclosure to meet the listing requirements in Vienna.
“We do not rule anybody out, but what we want is quality listings. That means the quality of the company, its corporate governance, but also the quality of its liquidity, which means a certain size of company because we do not want to disappoint investors if they find it is difficult to sell their position in that company later on,” says Mr Buhl.
Closer integration
In practice, however, a number of factors may begin to work in Vienna’s favour over the coming year. Poland has traditionally attracted issuers with the strong bid coming from its domestic pension fund industry, which is by far the most developed in the CEE region. But in 2011, the Polish government adopted a package to rein in a budget deficit of more than 7% of gross domestic product, which included cutting the state’s contributions into the so-called 'second-pillar' pension system that replaced the universal taxation-funded state pension in the late 1990s.
“The reduced state support for the private pension system could affect the so-far outstanding position of the Warsaw Stock Exchange. This is a process that the exchange will run through over the next few months, and we will monitor it carefully because it could reduce the dominant liquidity of the Warsaw market,” says Mr Grund of Raiffeisen.
The second vital change is the integration of both membership and trading onto a single CEESEG platform in 2012. This will give the three CEE member exchanges a fully developed central clearing counterparty for the first time; Ljubljana currently has no central clearing at all.
It will also give Prague and Budapest stocks access to the Xetra Euromarket electronic trading system via a single point of entry; Prague currently has no foreign members. Already, since Slovenia joined the euro in January 2011 and the Ljubljana exchange became part of Xetra, four remote members have joined the exchange and trading volumes are up 25%.
The 'big bang' full integration will reinforce Mr Buhl’s traditional stance that issuers should list first and foremost in their home country where media and research coverage is greatest. Indeed, two of Austria’s leading companies, Erste Bank and Vienna Insurance Group, have in recent years dual-listed on other CEE exchanges, such as Prague and Bucharest, to raise brand awareness for the subsidiaries they bought in those countries.
Regional approach
Even beyond the CEESEG members, Mr Buhl advocates dual domestic and Vienna listing for companies that want to access the euro-denominated equity markets. Membership of the eurozone is another significant advantage for Vienna, and EU member state Romania may offer an especially promising source of dual-listed IPOs in view of an International Monetary Fund programme started in 2008 that urges privatisation.
In January 2011, the Romanian government floated its holding fund Fondul Proprietatea (FP) on the Bucharest Stock Exchange, raising €1.2bn, adding 15% to total market capitalisation and a staggering 80% to the free float on the exchange. Trading volumes have increased 10 times since the previous year.
“We regard Romania as one of the priority markets for our ECM activity, with issues both from private companies, and from the privatisation programme. The very successful listing of FP definitely gave a boost to the Romanian market, because it is absolutely the strategy of the fund to exit some of their minority holdings, which will give further support to the ECM business,” says Mr Grund.
But the same blend of private sector activity and an ambitious public divestment programme also means Poland is Mr Grund’s other focus market in the CEE region west of Russia. In February 2011, Raiffeisen purchased a majority stake in Polbank, the 340-branch banking business network created by Greece’s Eurobank EFG, although Mr Grund says ECM origination business for the moment is coming from Raiffeisen’s existing branch in the country.
Integration of activities
More generally, the clustering of IPO activity around Warsaw and Vienna creates an imperative for ECM bankers to integrate their own activities across the region. The Raiffeisen group went through a reorganisation in 2010 that involved merging the customer business of Austria-based Raiffeisen Zentralbank (RZB) with the Raiffeisen Bank International subsidiaries across 15 CEE countries.
“Raiffeisen Centrobank had always acted as the ECM competency centre for the individual country units, but what has improved is the relationship between corporate banking and the equity origination teams, we have much more interaction with the CEE country banks now,” says Mr Grund.
For brokerages and investment banks based in individual CEE countries, there may be increased pressure to expand beyond their borders. The VSE now has three Romanian members, and the Czech-headquartered brokerage Wood & Co opened full-service investment banking activities in Poland in 2010, appointing UniCredit’s former head of CEE equities, Pawel Tamborski, as its head of CEE investment banking.
The equity market integration is also setting the CEE region on a different course from western Europe, where the multilateral trading facilities (MTFs) and so-called 'dark pool' trading platforms created under the EU’s Markets in Financial Instruments Directive (MiFID) regulations have tended to fragment trading and make it more difficult for investors to identify best execution pricing. Mr Buhl says almost all the trading of the three CEESEG members is on exchange, with MTFs conducting at most 10% to 12% of trading in Vienna-listed stocks.
Like the largest exchanges, MTFs are focused mainly on blue-chip stocks with the size of free float that allows the type of algorithmic and high-frequency trading that participants prefer to keep away from public markets. Mr Sobolewski says algorithmic trading is technically possible on the WSE, and high frequency will become possible with the introduction of a new trading platform in 2012. But at present, there is limited interest among market participants and that seems unlikely to change if Warsaw continues to pursue its strategy as a specialist SME market.
