Examination of Witnesses (Questions 20-39)
SIR BRIAN WILLIAMSON, MR HUGH FREEDBERG, MR JEAN-FRANÇOIS THÉODORE AND MR GEORGE MÖLLER
TUESDAY 22 JANUARY 2002
20. Mr Théodore, in answer to the Chairman you said you were committed to developing LIFFE business in London. Why are you not transferring the Amsterdam base of European equity options business to London in that case?
(Mr Théodore) Our equity options business, which is Dutch for the main part but also French and Belgian, will be put under the LIFFE umbrella. It will be run by management and we would inject maybe some expertise from our side but it will be global LIFFE management. We will put in a system which would be CONNECT-adapted to some specificities for our options. So, globally speaking, LIFFE will be the Euronext centre for derivatives.
21. There is no advantage in transferring that business to London?
(Mr Théodore) I think in a way what we are engaged in is the computerised market, including computerisation going on in Amsterdam. George Möller might want to elaborate on that.
(Mr Möller) Our concept in Euronext itself is that we have the contracts in the jurisdictions in which they belong - let us say Dutch securities in the Netherlands, French securities in France and what have you - but we choose one technical platform, which will be LIFFE CONNECT and one coherent management structure which will be under the umbrella of LIFFE. As I think we have progressed as Euronext in Europe, we do not want to move everything to one centre because there are still a lot of investors either in France, Belgium or the Netherlands who still want to see their products close to their home. The concept we have laid out for securities, which is now successful, is one where we have one line of command; we have one system but we respect the different jurisdictions.
22. How much control will London-based management have over the Euronext Amsterdam derivative market?
(Mr Théodore) The person responsible for the Euronext options derivatives business line has become a member of the Executive Committee of LIFFE and in that way co-ordination between our two businesses will be ensured.
23. Are we talking about co-ordination or management from LIFFE?
(Mr Théodore) A combination of management skills, with LIFFE knowing well about fixed income derivatives and the CONNECT technology and maybe our people, and especially the people in Amsterdam, having some equity expertise, retail equity expertise. Amsterdam is the most successful market in options for retail investors. We think that will be a successful combination.
24. Going back to the original question, Mr Théodore, how much control or influence will the London-based LIFFE management have over the Amsterdam derivatives market of Euronext?
(Mr Théodore) The person responsible for the equity derivatives business is a member of the Executive Committee of LIFFE and the chairman of this Executive Committee is the CEO of LIFFE, Hugh Freedberg. The issues will be discussed in the LIFFE board.
25. So the board of LIFFE will be in control of that business?
(Mr Théodore) Yes, but of course regulation for Dutch, Belgian and French options will have to be discussed with the national regulators.
(Mr Möller) From an historical point of view, when we started the equity option business in the Netherlands, it was to be a joint venture between London and Amsterdam at the time. I think it broke down one or two weeks before it started. What we are achieving now is officially what we set out to do 25 years ago.
26. Do you envisage moving some LIFFE contracts, such as equity options, to the Euronext-Amsterdam derivatives market combined?
(Sir Brian Williamson) No, but if I can perhaps add something which I hope is enlightening. The attraction from LIFFE's point of view, and I think from London's point of view, is that, although we have been very successful in derivatives and in a lot of derivatives on equities, we have not been successful in London in trading continental equities and futures and options on those. In Amsterdam they have been notably successful. In America it has happened and in Europe Amsterdam is the leading market for that. What we gain is some expertise in the retail side of that, which we failed to develop in London. The reverse is that although the contracts, if you like, do not move in that sense, to put them on one technology is attractive to us and that is a much more overriding issue for us, the integration of Amsterdam. They have now to go through what we went through, moving from a floor-based system on to a technology-based system. The importance of the deal to us is that we get as many contracts as possible on to that one single piece of machinery. That is what we are after. I think the direct answer to your question is "no".
27. Sir Brian, how important was the decision by Euronext to adopt your derivatives trading platform as distinct from what I believe was the London Stock Exchange, which was to weld your platform to their SETS platform, that Euronext wanted to adopt your system, rather than the LSE proposal to welcome you to theirs? Was it a factor; was it a very important factor; or was it not a factor at all?
(Sir Brian Williamson) I would like to use the word "huge" but perhaps "overwhelming" would be better. The reason for that is that the way we look at markets from the derivatives perspective is, I think, very different from the way the Stock Exchange does. Mr Möller can explain this to you later. A derivatives market is what it says: it derives from other markets. We exist only if we serve those markets. In London those markets are very international and very large, about £4,000 billion a day. So we have to cover the whole patch as a derivatives market. Our technology was non-existent three years ago in this field and we were being robbed; we were losing; we were going out of business. We had to develop that in order to accommodate all these markets from the very complicated ones in the money markets and the related markets and foreign exchange to bond market, as well as the equity market. So that is what we embarked on and I think we were successful in that and had a business plan which our shareholders were comfortable with. Euronext's proposition was to bring more business of a derivative type that we understood on to that machinery; that immediately accelerated our business plan in the area where we have competence and expertise. To that extent, that was an overwhelming case.
28. Could I ask a question of Mr Théodore? What advantages does the LIFFE CONNECT system offer over Euronext's originally proposed Next Derivatives System? What are the most obvious advantages?
(Mr Théodore) I could go into very technical issues, like speed, connectivity and a huge network, but to keep it simple, our users, who globally speaking were already using LIFFE, think that CONNECT is a very good system. Instead of developing our own system of perfection to try to match CONNECT, we thought it was better to bring our products to CONNECT.
29. In the Recommended Cash Offer document it states that in the combined entity that you are now the derivatives contracts are expected to be traded on LIFFE CONNECT. The word "expected" is used. I wonder if you would guarantee that, going forward, that is going to be the case.
(Mr Théodore) Yes, it is going to be the case but not the day after tomorrow. We have some time for migration. The technical time is short perhaps for French derivatives, which are already on a computer system, and the migration will probably take a little longer time for Dutch derivatives with the migration from open outcry. We will have to make some small enhancements in the CONNECT system to comply with the specific functions of our contracts. That is what I expect was meant by this.
30. It is used in that context?
(Mr Théodore) Yes.
31. So there is an end point at which you would expect all the derivatives contracts to go through CONNECT?
(Mr Théodore) Yes.
32. You are probably aware of some City comment and I have in mind in particular the Merrill Lynch comment. Perhaps I could read out what Manus Costello said, and I quote: "The merger of the five existing derivatives exchanges... leaves Euronext a lot to do over the next 12 months. There is in our view a far greater risk attached to integrating LIFFE with Euronext than with the LSE or Deutsche Börse... We think that the technical difficulties of integrating LIFFE into Euronext might leave the exchange more vulnerable to any attempt to poach its liquidity, as happened when Eurex took the Bund contract." I think what I am concerned about is the suggestion that it might leave the Exchange more vulnerable to any attempt to poach its liquidity". I wonder what your thoughts were on that.
(Mr Théodore) On Euronext and the LIFFE side
33. Are they more vulnerable to a poaching of liquidity?
(Mr Théodore) No, I do not think so. Any analyst is entitled to have his own opinion. Our vision is that the integration of our business, which is going to take some time and cost some money and effort, will produce a very strong and powerful contender in European derivatives. In European derivatives we can see very well that there are now only two players,-Euronext-LIFFE and a bigger player which is Eurex, and European competition in between these two. We are number two for the time being and we plan to be competitive enough and listen to others to become number one. I do not think that there is any kind of vulnerability. Globally speaking, the new Euronext-LIFFE combined group will have 30 per cent of its income coming from the cash business and 22 per cent - based on 2000 figures - coming from the derivatives business. We will be a very strong contender in the European securities business.
34. I wonder why you think that this is a view that Merrill Lynch and one or two others hold, and they refer to the technical difficulties of integrating LIFFE into Euronext which might lead to your vulnerability in terms of poaching your liquidity.
(Mr Théodore) Any migration takes a few months. In migration you are less strong than before starting to migrate but at the end of the migration you are stronger. The analyst you are quoting is completely entitled to his own opinion. I think that the market has not had the same opinion because the Euronext stock price has been rising, in what is not a very favourable climate, since the announcement of the LIFFE deal.
35. Your view would be - and the facts would seem to bear it out - that the costs and disruption of a switch to CONNECT has not had any adverse impact and you would expect that to continue?
(Mr Théodore) There are changes now in the competitive business. To be competitive, you have to be entrepreneurial and when you are entrepreneurial, you take some risk, but the judgment of the management of Euronext and of it's board was that the end result was worth it.
(Sir Brian Williamson) Will you allow me to be a bit blunter? Manus Costello is a very good analyst. Not long ago there were very few analysts who had the courage to write about exchanges. One of the advantages of the demutualisation is that we incur some attention now. He is an exceptionally good analyst. This was clearly a bad day! When the Select Committee came and visited us at LIFFE, we were in an extremely vulnerable position and, by the way, we got some considerable help for the United States, from this Committee and from the Government, for which we are very grateful. At that point, we were very vulnerable. We had to go through an exercise of huge vulnerability and move from a floor-based system to a screen-based system at the same time as huge changes were taking place in Europe. We were very vulnerable there. I think we ought to be given some credit for being able to manage that. As we watch other exchanges going through that process, without arrogance, I think we have some pride that we can accomplish that. We are now on version 6 of CONNECT and at times this is a hair-raising business keeping ahead of technology. We have a dedicated team to do it and the management understands the transition. So I really do not feel that he is right in portraying that vulnerability. If you do not do it, you are very vulnerable.
Mr Ruffley: That is very helpful.
36. Just a few points of detail on what you have said, which I thought was extremely interesting: how long is it going to take you to complete what you describe as the "migration"? You said it is going to be a few months. How many months will it take? I think the market would be very interested to know.
(Mr Théodore) I am sorry but we are not quite ready yet, since the operation is not closed, to give a proper answer. I think it could be a matter of a few months for products that are already computerised and maybe a little longer for products being traded. Really it is too early and we are only starting to work in combined teams.
37. You must have some sort of business plan, if only on the products that are already computer-based. Is it two, three or four months?
(Mr Théodore) I do not know if George can comment on that. My immediate answer would be that it would take a little bit longer than that.
38. And for the non-computer based products a little bit longer than `a little bit longer', so six months or eight months?
(Mr Möller) I think we will go through two migrations, and this is very important. Part of the trading on the equity option business in the Netherlands is still on the floor. It has been very successful, I have to say. We want to transfer its success to the screen because, if not, then I think we have done a conversion but it has not been done successfully. A lot of exchanges in the world which have moved over now to the screen have lost part of their volume. So I think we have to go through these steps one at a time. We have to be very careful in the process but there is no doubt in our minds that we will complete the process for one single trading platform, simply because that is efficient for the company and it is what users, at the end of the day, want. But I think in the transition period we have to be careful as well because liquidity is a very vulnerable issue. We have a competitor called Eurex who visit all our products and all the users are linked to Eurex. If we make mistakes there, then they can trade tomorrow. So I think we have to be careful. We will be very determined.
(Mr Théodore) Going back to complement my first answer, it is clear that it is in our interests, as the analyst quoted, that the migration should be as fast as technically possible. Coming back to what I said, we are not ready yet. We started on 10 January on combining the technical integration teams of LIFFE and our own teams and we are preparing to give some migration vision at the time of the announcement of our yearly accounts in early March. We are not ready today to give such a precise answer to you.
39. You will also be offering a better product at the end of it, you feel. The other half of your attractiveness to your consumers - that they can move very easily and it is a very footloose industry, as you were pointing out - is your cost structure. What kind of reductions in cost to your consumers are you hoping to be passing on?
(Mr Théodore) The business plan we have with LIFFE of course will mean some reduction of costs in putting our products on CONNECT rather than developing a completely new system or perfecting the old system. The main part of the business plan is in developing income, in having new products and being able to fight some battles which we jointly lost against our big competitors - in fixed income derivatives, for instance, the long part of the Bund or the long part of the yield curve in European-denominated products, launching single stock futures and to have these types of ventures. By growing incomes we think we will have a better business plan.