Stock Exchange, also known as bourse, the organization that facilitates the trade in company shares or other types of securities, such as bonds, unit trusts, and derivative products. Today, they fulfil several objectives: allowing a company to raise capital by floating its stock (often known as an “initial public offering”, or IPO); giving investors a way to participate in a company’s success by sharing in their profits (through share price appreciation and dividends); and allowing access to securities covering more esoteric investments such as commodities or pooled investments. Increasingly, stock exchanges such as Deutsche Börse, based in Frankfurt, provide more than just a trading venue and can offer transaction settlement services, provision of market information, as well as the development and operation of electronic trading systems.
For a company to raise cash for investment or day-to-day operations, it can either borrow through the banking system or issue stocks or bonds. This issuance takes place in the primary market, which involves large investment banks and investors purchasing these shares through an IPO. Subsequent trading of these shares or bonds takes place on the secondary market, through the stock exchange. Exchanges have regulations to which companies must conform in order to be allowed to use their facilities. These rules differ but generally include the publication of audited accounts, announcement of corporate actions, and payment of dividends. While there have been stock market crashes and scandals in the past, the greater level of regulation and oversight by institutions mean such occurrences are rarer. However, because some exchanges have higher levels of regulation and listing requirements than others, they may be more attractive for a company to list on. These requirements may be based on company size in terms of income or capital worth and how long it has been trading.
Since the 1980s, many developments in the structures and operations of stock exchanges have seen them hugely changed from the time of their inception. The earliest form of a stock exchange is believed to have emerged in France in the 12th century and was primarily based on the central trading of government-issued securities. Unofficial markets existed across Europe through to the 17th century, and the Amsterdam Stock Exchange opened in 1602, is credited as having been the first to have issued and traded shares in a company—the Dutch East India Company. The London Stock Exchange (LSE) is one of the world’s oldest and largest. It started in the coffee-houses of London in the 17th century. By 1761 groups of stockbrokers had formed a club to trade shares and 12 years later they built their own exchange with coffee-shop above. By 1801, it had reopened on a membership basis and London’s first regulated stock exchange began.
The mutual structure of an exchange such as London’s has been one characteristic that has changed most recently. Many stock exchanges have themselves floated shares to become listed companies. For many years the dominant players in the world of stock exchanges in terms of the value of companies listed with them have been the New York Stock Exchange (NYSE), the LSE, and the Tokyo Stock Exchange. However, just as institutions have demutualized, developed electronic trading systems, and handle ever-more complex forms of securities, so too has the competition. The NYSE is today known as the NYSE Euronext since its acquisition of the Euronext group, completed in 2007. In 2008 NYSE Euronext announced that it plans to take over the American Stock Exchange (Amex). The Euronext group is a rare example of a multinational exchange organization, providing services for regulated markets in Belgium, France, the Netherlands, and Portugal, and derivatives for the United Kingdom. In the face of this form of the competitive market with exchanges such as Deutsche Börse growing, and the merger of Euronext and the NYSE, players such as the LSE have merged with other exchanges such as Borsa Italiana, based in Milan. Additionally, as emerging economies develop, in particular in South East Asia, exchanges in places such as Hong Kong and Singapore become more important.
However, the leap in technology (and in Europe, a changing regulatory environment) has created even more competition with an increasing number of alternative trading systems known as Electronic Trading Networks (ECNs), such as Instinet. These systems boast lower costs. A further important “exchange”, although of a much less regulated sort, is the National Association of Securities Dealers Automated Quotation (NASDAQ) system. This is a computerized market linking dealers throughout the United States and, to some extent, Europe. The computerized nature of the NASDAQ pre-empted what is now a more common method of trading on exchanges throughout the world. Computerized systems have increasingly replaced the traditional stock exchange “floor” where dealers and stockbrokers met and traded by face-to-face “open outcry”. The LSE has been entirely computer-based since the reorganization dubbed the “Big Bang” in October 1986, with dealers able to see all prices on-screen instantaneously.
Other technological developments have also changed the face of the markets and the world of exchanges. The Stock Exchange Automated Quotation International (SEAQ International) system allows French shares to be traded in London, for example. SEAQ International has been dramatically successful in capturing market share from the domestic stock exchanges of many countries, to the extent that, for some countries, a larger proportion of trades takes place in London than on their own exchanges.
As competition between exchanges has developed, the trading systems of stock exchanges have divided into two broad categories. First, in order to reduce volatility and increase share liquidity, many exchanges use the “market-maker” or “liquidity provider” system. There are variations on how this system works but essentially a market-maker is a financial company that provides a price at which it is prepared to buy and sell each share. It can make money on the “turn”, which is the difference between the sell and the buy price and is known as the spread. Usually, the largest of the companies traded on an exchange in terms of capitalization does not have market-markers. Exchange regulations dictate that the best of these quoted prices are used when an investor’s order to buy or sell shares goes to a stockbroker, who in turn passes the deal on to a market-maker who will execute it. All the prices are visible on computer screens, and market-makers are committed to honouring their prices for trades up to a certain size (the “normal market size”, or NMS).
The second type of trading is the “auction” system, which has a matched-bargain or order-driven basis whereby all buy-and-sell orders from investors are collected together and matched, with the price being set to attempt to clear the market.
Individual countries seem loath to give up their domestic stock exchanges, although as financial markets are now so liberalized, and as information technology develops further, there is nothing to stop individual investors using whichever stock exchange system is the cheapest or most efficient.
Reviewed By: Gerard O’Kane
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