Like Frankfurt’s skyline of bank towers, the rise of the city’s securities exchange is an impressive thing to behold. Prior to its privatisation in the early 1990s, which gave rise to Deutsche Börse, the exchange was not much bigger than Germany’s seven other regional exchanges and was dwarfed by the securities exchanges of London or New York.
Today, though, Deutsche Börse is a securities exchange giant, only second in Europe to its arch-rival, the London Stock Exchange (LSE). Even more impressive is what Deutsche Börse has achieved in derivatives trading. Its electronic exchange, Eurex, is the world leader in trading of this extremely high-volume asset class.
High-tech business
Much of Deutsche Börse’s success stems from its introduction in the late 1990s of highly efficient and low-cost electronic trading for nearly all of its financial products, whether stocks, bonds or derivatives. In doing so, the exchange won over a huge number of international and domestic institutional investors, or in other words, the people who trade hundreds of billions of euros worth of securities.
The rise of Frankfurt’s exchange has been accompanied by the fall of Germany’s regional exchanges. Still largely wedded to floor trading, the exchanges simply have not been able to compete on volume with Deutsche Börse’s high-tech approach.
The regional exchanges were also dealt a heavy blow in the early 1990s, when big commercial banks such as Deutsche Bank, Dresdner Bank and Commerzbank ceased trading with them in favour of Frankfurt. The result is that, currently, more than 90% of all stock trades and 65% of all bond trades in Germany are done with Deutsche Börse. Derivatives trading, meanwhile, is almost entirely the domain of Eurex.
Even so, one regional exchange has managed to stop Deutsche Börse’s complete conquest of German securities trading: Stuttgart – a city normally known in Germany for its manufacture of exclusive cars Porsche and Mercedes-Benz.
Back in the late 1990s, Börse Stuttgart, the operator of the Stuttgart exchange, realised that the market for securitised derivatives was still up for grabs in Germany, despite Deutsche Börse’s might. Used exclusively by retail investors, securitised derivatives include warrants on company stock on the one hand and Zertifikate (certificates) on the other.
While warrants, which grant the right to buy shares at a fixed price in the future, are familiar among risk-oriented investors worldwide, certificates are not well known outside the European continent. One could loosely compare them with investment fund shares. Like fund shares, certificates range from the safe, which track benchmark indices, to riskier ones based on commodities. A key difference is that certificates typically carry lower fees than fund shares as they often involve a passive approach to investing. This makes them attractive to cost-conscious investors.
Rainer Reiss, Deutsche Börse: 'We aim to become market leader in securitised derivatives'
Identifying potential
Though Deutsche Börse had offered trading of these products since 1990, it failed to see their enormous growth potential. Börse Stuttgart, on the other hand, was quicker on the draw, and in 1999 it launched the European Warrants Exchange (Euwax) to promote trading of securitised derivatives.
“The original idea for Euwax did not come from the exchange’s board but actually was the brainchild of a Stuttgart trader named Hans-Peter Bruker,” recounts Andreas Willius, co-chief executive of Börse Stuttgart, in an interview with The Banker.
“Mr Bruker realised that in order for Stuttgart to better compete with Frankfurt and the other exchanges, it had to find a niche market. And there was one: risk-oriented private investors like day traders and cost-conscious investors looking for professional trading of derivatives. And for the last two years, more conservative private investors have discovered the Euwax products as alternatives to fee-laden mutual funds,” says Mr Willius.
Thinking back, Mr Bruker, now a member of Börse Stuttgart’s supervisory board, is probably amazed at how right on the mark he was. According to figures provided by the Stuttgart exchange, Euwax has captured no less than a 90% share of warrants trading against just 9% for Deutsche Börse. Euwax also has a 55% share of certificates trading versus 43% for Deutsche Börse, though the race for leadership in this segment is very tight, admits Börse Stuttgart. For example, in December 2003 Deutsche Börse overtook Euwax in certificates trading owing to a one-time trade worth €400m.
“If, however, you remove this one-time effect, we are still the leader in certificates with 55%,” notes Harald Schnabel, chairman of Euwax AG,specialist at the Euwax market segment.
Andreas Willius, Börse Stuttgart: 'If we had a monopoly, investors would not have the benefit of chosing between pricing models and prducts'
Growth industry
Even better for Stuttgart, securitised derivatives continue to be a high-growth market. There are now tens of thousands of warrants and certificates issued by all major domestic and international banks, including Deutsche, Dresdner, ABN AMRO, Citigroup and Goldman Sachs. Mr Schnabel, who helped launch Euwax in 1999, predicts that in this year alone, the market will grow 30%-40%.
One reason for such staggering growth is the relatively immature market in Europe for products such as certificates that feature a passive style of investing such as index tracking. Experts say that while 30% of retail investors in the US own funds that have a passive investment style, thatfigure in Europe is a mere 3%.
While impressive, Stuttgart’s success with securitised derivatives should not be overestimated. Since the niche market is dominated by retail investors, trading volume pales in comparison with the volume generated by, say, institutional investors trading derivatives on Eurex. Börse Stuttgart estimates that trading volume for securitised derivatives in Germany totalled €30bn last year, €20bn of which was done on Euwax. By comparison, derivative trades on Eurex have an underlying value in the trillions of euros.
Red-faced in Frankfurt
Stuttgart’s success has nonetheless been a source of embarrassment for Deutsche Börse, as Germany’s premier exchange was slow to identify a key growth market. Frankfurt has therefore struck back hard, unveiling in September 2003 a platform to compete head-on with Euwax.
Called “Smart Trading”, Deutsche Börse claims the new platform offers investors a higher degree of transparency and efficiency than what they get from Euwax. Specifically, the exchange says, Smart Trading guarantees that an order for a warrant or a certificate is executed at the quoted market price and within 30 seconds of it being placed. If the platform does not deliver on these guarantees, the order can be cancelled immediately.
Commenting on the main difference between Euwax and Smart Trading, Rainer Riess, Deutsche Börse’s head of stock market business development, says: “Smart Trading offers retail investors the highestexecution quality. For example, we guarantee order execution within 30 seconds. With Deutsche Börse as market organiser, investors benefit from the professionalism and fairness of an internationally leading stock exchange operator.”
For Euwax’s part, Mr Schnabel observed that the exchange has offered these same advantages to retail investors since its birth five years ago. “If you ask me, Smart Trading is in essence a copy of Euwax’s successful business model. It doesn’t provide the investors with any real added value,” he said.
Considering that Deutsche Börse has so far not seriously challenged Börse Stuttgart’s predominance in securitised derivatives, Mr Schnabel may be right. Then again, there are already signs that Deutsche Börse is quickly catching up in this niche market. Mr Riess comments: “Our strategy for this segment is a long-term one. One shouldn’t expect substantial changes in market share after several months. We are, however, very pleased with the way things are going and aim to become market leader in this segment.”
Staying in the game
Experts say that at the very least, Euwax’s success has enabled Stuttgart, unlike other regional exchanges, to remain relevant in the German securities industry. “Stuttgart wisely understood that if it wants to survive in an industry increasingly dominated by one player, it had to find a niche market,” remarks Professor Wolfgang Gerke, an expert on the German securities industry at the University of Nüremberg.
Stuttgart has remained relevant for another important reason. Though few institutional investors use floor trading anymore, many retail investors in Germany still prefer it, as they often can get a better price for a stock than on, say, Deutsche Börse’s Xetra electronic platform. Of the volume that is therefore generated by floor trading, Stuttgart takes second place with a 34% share. Admittedly, this puts the exchange behind Frankfurt, which has a 58% share, yet leagues beyond the other regional exchanges, which split the remaining 8% between them.
Experts say that since regional exchanges other than Stuttgart no longer play a meaningful role in trading volume, their operations are unprofitable. Thanks largely to Euwax, Börse Stuttgart continues to earn money, though its profitability has diminished recently. Profits shrunk to €1.5m in 2003 from €5.7m in 2002. It attributed the decline to stepped-up investment in IT, but added that developments in turnover, which rose to €49.8bn in 2003 from €44.6bn in 2002, were encouraging.
Börse Stuttgart’s competitive position is further boosted by strong leadership. Mr Willius and the exchange’s other co-chief executive, Elisabeth Roegele, are themselves experts on the German securities industry. Prior to joining Börse Stuttgart in 2002, Mr Willius was director of capital markets at Bankers Trust in Frankfurt, which is now part of Deutsche Bank. Ms Roegele, a lawyer by trade, gained valuable experience as a regulator of Deutsche Börse in Hesse’s economics ministry between 1996 and 2001 before moving to Stuttgart.
Aware that they have become largely irrelevant in terms of trading volume, Stuttgart’s peers have looked to other means of attracting investors. A good example are those in Berlin and Bremen, which endeavoured to be part of the recent European expansion by the US electronic exchange, Nasdaq. In the end, however, “Nasdaq Europe” never really went anywhere, leading the US exchange to call off its cooperation talks with Berlin and Bremen. Bremen is now expected to halt trading at its exchange and merge with Hamburg.
Political factors
If Stuttgart’s peers have become insignificant in terms of trading volume, why do they remain open? The answer, says Mr Willius, is that because the exchanges are still captive to state governments under Germany’s federal system, politicians, rather than the market, decide their fate.
“The German exchange landscape is fragmented because in 1951, several federal states decided to perpetuate their exchanges to help finance corporate Germany, which was and still is fragmented. You have, for example, shipping in Hamburg and auto manufacturing here around Stuttgart,” Mr Willius says.
“Until the late 1990s, the exchanges made plenty of money and then hoarded it. This is partly why they have been able to survive even when almost all of the trading is done in Frankfurt or in Stuttgart. The other reason, of course, is political, because none of the Bundesländer [state governments] want their exchanges to be closed.”
Dashed hopes
In any event, continued fragmentation of the German securities industry dampens hopes that Europe, which has a single currency, might one day have an integrated securities exchange. Such hopes, expressed by people such as Rolf E Breuer, former chairman of Deutsche Bank, are not at all fanciful. Consider that by 2001, the Paris stock exchange merged with those in Amsterdam, Brussels and Lisbon to create the supranational exchange Euronext.
The year before, Deutsche Börse, emboldened by its new importance on the international scene, tried but failed to merge with the LSE. Consolidation of the European securities industry took another giant step in 2002, when Euronext beat Deutsche Börse’s bid for Liffe, London’s derivatives exchange.
While Mr Willius believes that consolidation of the German securities industry is essential and will, in fact, happen, he is sceptical that Europe will ever move toward an integrated securities exchange.
“It’s definitely a possibility, but it depends on moving to a common clearing and settlement infrastructure. I can’t, for example, offer Euwax’s services to an investor in Clermont-Ferrand, since we are on Deutsche Börse’s Clearstream standard, while his trades are cleared by Clearnet. I doubt that this situation will ever change in our generation,” he says.
On the other hand, Mr Willius stresses that the current state of the German and European securities industry is probably a blessing. “I’m pleased with the state of the industry, as the existence of many players ensures competition. If we had a monopoly, investors would not have the benefit of choosing between various pricing models and financial products.”
