Written By: Morgan Jones – Corporate Finance
Just weeks after the failed merger with Deutsche Börse, the London Stock Exchange (LSE) group is back on the offensive. The LSE will spend $685 million (£534 million) to strengthen itself in the index market. It will buy the fixed-income analytics platform and index business of the American Citi, including the World Government Bond Index, the most famous index for sovereign bonds in the world. The transaction also includes The Yield Book, a platform that offers a set of analytical tools for traders and investors in government, corporate and mortgage bonds, and derivatives. The deal is expected to close in the second half of 2017, after obtaining regulatory clearance.
With this deal, the LSE will strengthen the analytics capabilities of its information services. Financially, the LSE is expecting an increase in revenues of $30 million over the first three years after completion and cost savings of $18 million. The LSE thinks its core profit margin could rise at least 50 percent within three years of the deal’s completion.
But markets do not wait, and the LSE will have to face its American competitors. After the failure of the merger project with Deutsche Börse, and the threats of European politicians to dismantle London’s euro-clearing activity after Brexit, the LSE must concentrate on its future.
The significant market growth of indices for ETFs (exchange-traded funds) and passive management over the past years is now reaching a consolidation step. This means the necessity to find synergies and reduce costs.
Passive management (also called passive investing) is an asset-management mode that tries to duplicate as closely as possible the performance of a stock index (CAC 40, Dow Jones, S&P 500). It does so by composing a portfolio that reproduces the targeted market index. Between 2010 and 2017, assets of passive funds increased from about $2 to $7 trillion, invested more than 80 percent in equities. Passive-managed assets now account for almost one-third (32.5 percent) of total assets under management (excluding money-market funds)—a market share that has been growing steadily since 2010 and that even accelerated in the last months of 2016.
But at the same time, passive-management funds have been pushed to lower their costs, with criticism launched against the costs of the major index-makers: S&P Dow Jones, FTSE Russell and MSCI. Pressure from fund managers for lower provider fees is growing; exchange-traded fund managers find the bills from index providers too high, with their business models based on low fees.
According to the Financial Times, in an article titled “ETF providers float idea of setting up their own market indices”, some giants of passive management are even threatening to create their own indices, without S&P Dow Jones, FTSE Russell or MSCI. According to the Financial Times, they would consider launching their own “indices factory”, a kind of co-operative or group of professionals. This idea, however, has not yet become a concrete project, in the sense that many obstacles could be faced—the major one being anti-trust regulation that could prevent the participants from cooperating together in such a co-operative company. Moreover, it is difficult to know in advance how less costly it would be for the players to set up an independent structure, rather than to continue using the suppliers of historical indices.
For the LSE, following its past acquisition strategies, finding synergies will become crucial to decrease costs. In 2014, the LSE, owner of the Footsie (FTSE 100) index range, had already invested $2.7 billion (£1.6 billion) to buy back Russell Investments, before buying in 2016 US-based Mergent, a company specializing in information services and data for the financial markets. The LSE estimates that the future market for assets under management using its indices as references could reach $15 trillion.
With the explosion of passive management, the income of index providers tends to soar. According to the Financial Times, S&P Dow Jones Indices—the world’s largest index provider—increased its revenues by 7 percent to $639 million in 2016; MSCI’s revenues increased by 9.8 percent to $613.6 million; and FTSE Russell’s by 17 percent to £409 million.
The deal with the City is also illustrating the strong willingness of the LSE to develop on the international stage.
Nikhil Rathi, chief executive of the London Stock Exchange Plc in charge of the international development of the group, said recently, “we’ve always been a very global market” and “the reason people come to London is the rule of law, regulatory integrity, time-zone, depth of investor base, liquidity, fairness of the legal system…. Nothing that’s happened in the last year has changed that, or will change this fundamentally. This is a tradition in London that goes back hundreds of years”.
The group says it wants to “pursue selective acquisitions”; and whatever Brexit brings, the LSE is more than ever ready to take up future challenges.