A London-Frankfurt Axis

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One of the nastier surprises many investors noticed after the adoption of the euro last year was that it was still awfully expensive to buy stocks in companies located outside their home country. That was supposed to change when most of Europe's stocks were finally listed in a single European currency. But even though the euro made share prices easier to compare, investors had to contend with 15 national exchanges. That has meant transaction costs are up to 10 times higher for European customers than for their American stock-trading cousins.

But European investors may be finally getting a break. Last week's announcement that the London Stock Exchange was merging with Germany's Deutsche Börse not only created the world's third-largest exchange in terms of the market value of the stocks traded. It also means possibly major savings for investors, especially big institutions like pension funds that buy shares in huge quantities. "This merger wasn't driven by the euro or stockbrokers," says Mark Howdle, chief European equities strategist at Salomon Smith Barney in London. "It was driven by investors who want to be able to trade shares and settle their transactions in a single place."

Under the deal, the London and Frankfurt exchanges will each own half of the new company, to be called the iX — pronounced eye ex, and short for international exchanges. The merger recognizes the City of London's pre-eminence in European financial affairs by basing the trading of blue-chip companies in London. The two exchanges currently account for about 53% of the volume of European share trading and 135 of Europe's 300 largest companies. At the same time, iX and the U.S. stock market nasdaq, the favored exchange for America's hottest high-tech firms, agreed to become equal partners in setting up a specialized market for high-tech stocks in Frankfurt. Significantly, the exchanges agreed to adopt the Frankfurt exchange's Xetra computerized trading system rather than London's trouble-plagued sets system, which suffered a massive outage last month, paralyzing trading in the City for an entire day.

Werner Seifert, the 50-year-old Swiss who runs the Frankfurt exchange with an iron hand, will be chief executive of iX, a tribute to Seifert's management skills. Only a decade ago, the Deutsche Börse was the butt of many unkind jokes in the investment community. No more. While London has higher turnover than Frankfurt, the German operation is more profitable. What's more, under Seifert's guidance, Germany's high-tech exchange, the Neuer Markt, has left London's techmark in its dust. He also brought together the Swiss and German future exchanges to create Eurex, now the world's largest market in financial derivatives. "You have to think more and more of the challenges of the global marketplace,'' said Seifert last week.

While one market is certainly better than two, what of Europe's other exchanges? Milan and Madrid have already signed memorandums of understanding to cooperate with iX, and there is speculation they will join up by next year. That would put immense pressure on the Paris, Amsterdam and Brussels bourses, which announced their own merger two months ago into a joint market called Euronext. All of Europe's exchanges had tried to create a working alliance last year, but the negotiations foundered over such matters as what trading system to adopt.

As trading is electronic, the physical location of the exchanges doesn't mean much anymore. Most analysts follow industries by sectors and have been based in London regardless of where the companies they follow are located. Sure, German companies will have to meet British listing requirements, but this is the cream of German industry and they should have no trouble. What's really important is that two old economy exchanges got together to form a trading platform that can compete in the new economy. With rival online trading systems knocking at the gates for business, the merger was really the only way to ensure their continued survival.