Success of SGX-ASX deal yet to be seen

Recent changes in the Australian market and differences in legal and regulatory regimes between Australia and Singapore pose execution challenges for the two exchange companies.

In a statement, Moody’s says that although the merger has implications for all major global players, it does not expect Western exchange groups to respond with large-scale acquisitions, which is credit-positive. “If the SGX-ASX merger clears the steep regulatory, government, and shareholder approval hurdles in both countries, it would create a diversified, vertically integrated cash equities and derivatives exchange supported by secular Asian growth and a strong legal and regulatory regime. The deal’s intended strategic rationale rests on both expense and revenue synergies.” it said.

The ratings agency said the exchanges’ operating leverage makes expense synergies an integral driver of sector consolidation, but one that requires disciplined and skillful execution. Both exchanges have the same technology platform, which should ease integration albeit while limiting potential savings. Headcount-related savings may also be limited by operating under a dual regulatory regime, with all the corporate governance and local labor law constraints this entails. Nonetheless, management should be able to extract some savings from the combined $360
million expense run-rate.

“Revenue synergies include growing trading volumes and attracting new listings. While the SGX CEO summed up the opportunity as ‘one plus one definitely equals four,’ the history of cross-border exchange mergers suggests that on the revenue side, one plus one seldom exceeds two,” Moody’s said, adding, “combining liquidity pools to deepen overall liquidity requires seamless cross-border clearing, settlement, and custody. Differences in legal and regulatory regimes between countries make this very difficult to achieve. Without deeper liquidity, most revenue
synergies are either unrealizable or have a marginal impact."

Indeed, in the short and medium term, getting one plus one just to equal two is not guaranteed. Though both exchanges are currently monopolies in their markets, the structure of the Australian market is about to change. In August, the Australian Securities & Investments Commission (ASIC) assumed supervision of trading on Australia’s listed markets, which had previously been carried out by ASX. This clears the way for ASIC to issue new market structure rules centered on competition for market services, a policy goal of the Australian government. Chi-X, an alternative trading system owned by Nomura, whose low-latency, 2 ultra-low trading cost strategy has been successful in winning market share from incumbent exchanges in Europe and Canada, has already been approved “in principle.”

Chi-X, and those that follow it, will chip away at ASX’s market share and pricing power, and the merger will not prevent this. Still, the erosion should not be precipitous: unlike Chi-X’s previous victims, ASX has a low-latency platform of its own. It will also control all clearing and settlement, thus retaining more pricing power than is usually the case.

Moody's said, "The merger also heightens the urgency of participating in the Asian growth story for our rated exchanges. However, we do not expect them to respond with large-scale acquisitions. The valuations and price-earnings multiples of Asian exchanges make stock-based deals highly dilutive. Debt-financed deals would take the acquirers well beyond their leverage capacity, likely leading to rating downgrades and hurting customer perception of their clearing franchises."