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Second Stock Exchange Merger Reveals Trend

25 01 2007  Merger of Croatian stock exchanges seen as small step in broader consolidation foreseen for equities markets of south-east Europe.

By Goran Jungvirt in Zagreb (Balkan Insight, 25 Jan 07)

People in the business of trading stocks and bonds in south-east Europe have predicted for years that market pressure will force the region's small and disparate stock exchanges to merge. As evidence of such a trend, they could cite just one merger in Romania and a handful of technical agreements between exchanges, tiptoeing toward integration.

Next week, however, the region will see a second merger. Croatia's two stock exchanges, the ZSE in Zagreb and VSE in Varazdin, stand poised to proceed with a deal enabling the larger Zagreb exchange to absorb Varazdin's business. The proposed terms are said to be amicable, bringing shareholders and staff under a single roof. Shareholder approval from both exchanges is anticipated at assemblies scheduled to be held next week.

The ZSE, with market capitalisation of over 30 billion euro, will not grow by the full value of Varazdin's market capitalisation, 9.8 billion euro. There is a degree of overlap, since some Croatian stocks have been traded on both exchanges.

But size is not the primary goal, according to those involved in the deal. The main benefits anticipated in the merger will be lower trading fees and swifter technological upgrades. Zeljko Kardum, spokesman for the ZSE, likens the move to "buying a new car for delivering pizza. It remains to be seen by what amount our deliveries increase".

Indeed, the merger is only a small step in the broader consolidation foreseen for the equities markets of south-east Europe. Stock exchanges in the region still outnumber countries, despite almost universally low levels of market capitalisation and liquidity. Yet the ZSE-VSE merger is an important example of how market rationalisation is being invited by the region's renewed stability, as the shocks and imbalances of the 1990s fade into memory. In Croatia's equities market, as in other markets throughout the region, the damage of that decade has taken years to undo.

The ZSE, established in 1991, just as the former Yugoslavia descended into war, was always destined to be Croatia's largest exchange. Yet in the fragmented marketplace of the time, as the privatisation of state-owned companies rolled forward, frustrated businessmen in Varazdin, a quiet northern town, in 1993 founded their own "over-the-counter" market to speed the trade of local company shares.

The two exchanges evolved, but not always in parallel, for they initially served different markets. Zagreb grew apace while the nature of the Varazdin market - founded essentially as a bulletin-board where buyers and sellers posted offers, enabling traders to find each other - changed over time. In 2002, the Varazdin market relaunched itself as the VSE, a more sophisticated "exchange", equipped to automatically match buyers and sellers.

Talk of a merger began soon after, but neither exchange showed interest in taking the first step. "It was also blocked by small traders who had contrary business interests in the stock market," said Kardum.

Three years passed before the group of 12 leading Croatian banks and brokerages now known to exchange officials as "the Big Ones" brought market pressure to bear on the ZSE and VSE. The group, including the Croatian subsidiaries of Austria's Raiffeisen Zentral Bank, Erste Bank and Italy's Unicredito among others, purchased shares in the exchanges in order to turn talk into action.

Josip Galinec, director of TO ONE, one of the brokerage houses in the group of 12, said there is simple reasoning behind the merger. "It will not have any magical effect on trading, but it will simplify it and make it cheaper," he said. Among the changes brokers can look forward to is a halving of numerical and graphical clutter on their terminal monitors - following trading values "only on one screen rather than comparing between the two". Brokers and publicly-traded companies will benefit likewise from the elimination of a second fee, paid to the VSE, for comprehensive access to Croatia's equity markets.

Companies present on both markets will save the most since they will not need to pay two incoming fees, but one. Neither will they be required to fill in two books of warrants for trading their stocks, but one.

Technological aspirations also underpin the logic of the deal. Competition, while beneficial in some ways, encouraged both exchanges to keep costs low, and innovation moved down the list of priorities. “When you have two stock exchange markets you have competition, so you cannot invest in technology,” said Kardum.

Outdated IT infrastructure has left the exchanges unable to handle futures and options – trades in which buyers and sellers settle on future sales of commodities, in contrast to real-time exchange – and overburdened by personnel costs in areas where leading exchanges in Europe benefit from automation.

The ZSE on January 9 signed a contract with OMX, securing the Swedish-Finnish financial services company as provider of a new trading system for the exchange. Installation is expected by June this year. But the arrangement is significant beyond the immediate issue of technological upgrades. Statements made at the contract's signing pointed toward a growing role for the ZSE, and possibly also OMX, across the equity markets of south-east Europe. Roberto Motusic, managing director at the exchange, said the ZSE aims to "further strengthen our position in the region". Markus Gerdien, president of market technology for OMX, likewise said his company saw its partnership with the ZSE as a vehicle for the "development of financial markets in the region".

Such a move would not be without precedent. OMX has focused heavily in recent years on seeking new market efficiencies among small European exchanges, with a combined strategy of mergers, acquisitions and technological upgrades. Initially founded in the 1980s as OM, a futures exchange, the company since 1998 has gained ownership of exchanges in Copenhagen, Stockholm, Helsinki and Reykjavik, as well as three of eastern Europe's fastest-growing exchanges in Tallinn, Riga and Vilnius. OMX is currently bidding for the Ljubljana Stock Exchange, as well.

Although Croatian law prohibits foreign purchase of stock exchanges, Kardum said "there is always a possibility" that OMX may make a similar bid for the Zagreb exchange. South-east European exchanges could potentially fit under a single roof, as those in Tallin, Riga and Vilnius have done within OMX's unified Baltic Market. The ZSE, as the region's largest exchange, with the exception of Austria's Wiener Boerse, could be a launchpad for a similarly unified Balkan market.

Powered by a surge in trading of top Croatian companies such as Pliva, the drug maker purchased last year by Barr, a US company, and state-owned oil company INA, the ZSE now far surpasses the Ljubljana exchange's market capitalisation of 19.8 million euro.

However, the Balkan market presents challenges not present in the Nordic and Baltic markets, not only economic but political. Bosnia and Herzegovina, for example, has stock exchanges in both Sarajevo and in Banja Luka - a consequence of the country's post-war division into separate Bosniak-Croat and Serb sub-states. To the bewilderment of brokers, even the newly independent republic of Montenegro, with a population of just 650,000 and an acute shortage of quality stocks on offer, also has two exchanges - the Montenegro Stock Exchange established in 1993 and the New Securities Exchange opened in 2001.

In Romania, the region's largest economy, the Bucharest Stock Exchange, BSE, merged with the Rasdaq, an electronic exchange, in 2005. Yet a third exchange in the city of Sibiu continues to work independently while pondering a possible merger with the BSE. Such fragmentation effectively bars large western investors from entry, because they require massive market liquidity in order to carry out large-volume trades securely. Smaller exchanges offer lower liquidity; mergers generally boost it.

Kardum cautions that the mergers alone do not make a market, "Buyers only come if you have good merchandise." A key example is the surge in trading of Pliva stock witnessed last year. Despite the fragmentation of Croatia's stock market at the time, some of the largest US and European investment funds found themselves trading on the ZSE, aiming to ride the growth in Pliva's value amid a bidding war between pharmaceuticals giants.

That round of heavy trading greatly enhanced the ZSE's reputation among central and eastern Europe's new exchanges. Whether the exchange can hold the ground gained last year and build upon it will depend not just on the merger with the VSE and partnership with OMX, but more broadly on the performance of Croatia's publicly-traded companies.


Goran Jungvirt is a freelance journalist and editor of Novac (Money), a business news magazine on Croatia's Nova TV. Balkan Insight is BIRN's online publication.