Central and eastern Europe’s derivative markets are patchy. With liquidity scarce, it makes sense to pool it. Warsaw Stock Exchange thinks it should be the hub – but Wiener Börse has acquired three CEE exchanges and wants to unify their markets. Which market has the most credible claim to be the regional champion? Mareen Goebel reports.
Central and eastern Europe was one of the most exciting investment themes of the past decade. Exposure to the region was a guaranteed way for companies – including financial firms – to make equity analysts upgrade their forecasts.
Since 2008, the euphoria has crashed to earth. Banks with large east European loan books have been punished in the stockmarket, and countries including Hungary, Ukraine and Latvia have veered perilously close to financial catastrophe.
The one economy that has been able to keep holding its head high is Poland. Now the Polish financial markets’ success has been crowned by another event, long looked forward to by some participants. On November 9 the Warsaw Stock Exchange's shares began trading after a Z1.2bn ($420m) IPO that was 25 times oversubscribed. The sale reduced the government's stake from 98% to 35%.
Blocked out by the noise coming from Poland, another initiative has gone if not invisible, then certainly underreported. Wiener Börse, Austria’s stock exchange, is behind what looks like at first glance one of the most ambitious projects in CEE financial markets.
The region’s fragmentation, with many small national exchanges, divides the already scarce liquidity up even further, a radically different pattern from the consolidated – at least in derivatives – west European landscape dominated by London and Frankfurt.
What many in the region are asking is whether one regional exchange champion will emerge, and if so, where and under what circumstances.
Liquidity puddles, not pools
The core problems for CEE exchanges are their lack of liquidity and international profile. “Generally speaking, there are only futures markets in Poland and Turkey with regards to the CEE region,” explains Manfred Sibrawa, head of eastern European equities at Austrian bank Bawag PSK. “Poland, Turkey and Russia are highly liquid markets, but not much happens outside those hotspots. In all other markets, there is not enough liquidity to speak of markets at all. The main problem is that the spreads are very wide and the market making system isn’t really established.”
Bawag’s activities in CEE are focused on portfolio investment, purely in equities. Sibrawa adds: “We could also do derivatives, convertibles etc, but as there is a lack of products so far we only use equities. Our main markets are Poland, Hungary, the Czech Republic, Russia and Turkey.”
The shallowness of these market is another serious problem. “The Hungarian index consists of three to four titles,” Sibrawa points out. “The market making system is partially established. In Hungary, the market is simply not deep enough. You can influence the market, and even control the small and mid caps with a few million euros to invest, which isn’t attractive for large institutional investors that we advise.”
Austria: has the gateway to the East closed?
It’s one of the most well-worn clichés about Austria, but Vienna has served for a long time as the ‘gateway to the east’, and financial firms there keep touting this as one of their unique selling points.
In this tradition – and supported in no small part by the existing CEE networks of the Austrian banks, whose growth has been fuelled by their rapid expansion in the region – Wiener Börse acquired three neighbouring stock exchanges in short order.
It bought a first stake in the Budapest Stock Exchange in May 2004 and subsequently expanded to a majority holding. In 2008, Wiener Börse acquired Ljubljana Stock Exchange and the Prague Stock Exchange.
Then in January 2010 the four were turned into subsidiaries of the holding company CEE Stock Exchange Group, which is dominated by Vienna.
The combined market capitalisation of companies listed on the four bourses reached €137.5bn in July 2010. While this accounts for around half of the whole market cap of the CEE region, Vienna has the lion’s share with just under €77bn.
Especially from a derivatives perspective, Wiener Börse’s creation of the CEE Stock Exchange Group has gone a long way to consolidate the landscape in eastern Europe. Of the four exchanges combined under the umbrella, all but Ljubljana offer derivatives.
Along with the acquisitions, Wiener Börse has been integrating the data feeds from Budapest, Ljubljana and Prague into its own data feed. In September 2009, Vienna launched the CEESEG Traded Index (CEETX) of the 25 most actively traded shares across its markets, and the CEESEG Composite Index, which includes all the stocks in each market’s index.
All four exchanges are hoping now for dividends from the merger – they want more liquidity, more strength, and a higher international profile for the individual exchanges and the CEE market they represent.
“The aim is to be a better competitor and to establish the biggest stock exchange group in CEE,” says Jiri Kovarik, director of external communication at the Prague Stock Exchange.
So far, however, Wiener Börse doesn’t appear to have done a lot with its new acquisitions.
The timing of the mergers was not exactly auspicious. The supporting foundation of the Austrian banks’ network has crumpled under the pressure of the credit crisis.
Prague: hoping for the best
Prague Stock Exchange introduced futures in September 2006, but the products have not really taken off. They include futures on single stocks and the PX Index, which comprises 14 stocks from the main market.
“Trading is not very active. While domestic investors seem to understand them, they still shun them and prefer to hedge risk by short selling and leveraged trading. Generally, the market isn’t used to derivatives,” says Kovarik.
What trading is done in Prague is by domestic institutions. PSE wants to increase activity through marketing measures and education, but concedes that “liquidity at the PSE is not deep enough” and that “domestic investors which we target know about the products and what they can bring, but they are simply too conservative to use them.”
Against this backdrop of shallow liquidity, the exchange “doesn’t foresee any further product development in derivatives in the near term”.
PSE has a fair amount of hope that the Wiener Börse takeover might reverse its fortunes. “We believe there will be substantial changes,” says Kovarik. “We are working on implementing Wiener Börse’s trading platform Xetra. It will be deployed across all the CEE exchanges that Wiener Börse owns, which will give their members access to our markets and vice versa.”
Since 1998 PSE has been using its in-house developed trading system Spad, and the switch to Xetra means a lot of extra work.
“The aim is to keep the advantages of the Spad system and customise the Xetra modules so they offer the same advantages that Spad did,” Kovarik explains.
Asked when the technological switch was due to happen, Kovarik said: “Introduction of Xetra has no fixed date, but we’re working on it and expect it to go live at the end of 2011/beginning of 2012. At the moment, we are talking to our members about how the switch-over will affect their operations.”
Additional work is happening on the legal side. While all exchanges are regulated under Mifid and the European Union provides the regulatory framework, “each country’s legal systems are different and each exchange has a different set of rules and regulations to follow,” says Kovarik.
What else can the CEE Stock Exchange Group offer?
“Cross-membership between all the markets,” Kovarik says, “will be a key advantage for our members and the members of the other participating stock exchanges.”
Budapest – ready for liquidity
The Budapest Stock Exchange’s story has much in common with Prague’s. It launched index futures and some currency futures in 1995. In 1998, single stock futures followed.
So far, BSE offers a full range of equity options and futures and currency futures. The most popular, accounting for around 30% of trading, is the Bux Index Future. Another third comes in single stock futures, while 40% is FX futures. But, again, options, while available, simply haven’t taken off.
“All markets in the region suffer from similar problems,” explains Attila Tóth, deputy CEO of BSE. “What activity there is comes from domestic retail investors. At the moment, foreign investors are simply not interested in the market, so right now the scope for derivatives in the market is fairly limited.”
Foreigners, Tóth says, are giving BSE a wide berth because there are not enough domestic institutional investors to give the markets the depth they seek. Therefore, he admits, “Activity is mostly driven by speculative retail investors who use futures because of the leverage they provide.”
Asked what the BSE expected to gain from the CEESEG project, Tóth said that he hoped that in a few years, all its products would be available on a single platform, allowing all members of all the exchanges to access them. “We are sure that the CEE Exchange Group project will help us reach economics of scale. But we’re also aware that there’s a lot of work to do on our domestic retail base,” he says.
Despite its current shortage of liquidity, Tóth is ambitious about BSE’s future reach. “We’re not only aiming at the exchange members in the CEE region, though, or to bring members of the Wiener Börse to Budapest. We have a much larger scope, which includes all the European investor community.”
Technical upgrades are on the cards here, too. At the moment, the exchange runs its own system, MMTS (Multi-Market Trading System), which was created by an Australian company and has been developed in-house. Switching to a shared platform is a matter of necessity for BSE. “Since this system is not is not used in the more developed part of Europe, connecting to us is also a matter of cost and effort for new investors,” Tóth says.
Asked when the shared technology platform would be introduced, he said: “We’re talking about running Xetra for the cash markets and Eurex for the derivatives market at a later stage, but there is no board decision made yet on the timing of the implementation.”
CEE Exchange Group – competition for Warsaw?
Opinions diverge on whether CEE Stock Exchange Group, marketed as “the largest player in CEE” in numerous press releases, poses a challenge to the Warsaw Stock Exchange, which, on its own, is the biggest derivatives market in the region and has long eclipsed Vienna.
CEESEG’s party line is that “the primary objective is to strengthen, advance and internally position the capital markets of our member exchanges in CEE”, while the medium to long term goal is to “raise liquidity at all stock exchanges of CEESEG”.
But so far, not a great deal appears to have happened. The software unification has not been implemented yet, market liquidity remains low (derivatives trading dropped by 15% on BSE in 2009 after a similar fall in 2008, though it has recovered about 3% so far this year), and tangible results are few.
Asked why CEESEG seems to be moving so slowly, while Warsaw is bounding ahead (volume up 54% so far this year), some players in the market suggest that when Vienna acquired the other exchanges, it “overpaid significantly on even the bullish evaluations of the boom years”. One source calls the valuations of the acquired exchanges “political”.
Wiener Börse responds: “We have paid a strategic price that was in accordance with the market value at that time.”
Asked what the mergers had actually achieved for its acquired exchanges, Wiener Börse replies: “Our partner exchanges are included in our road show programme to increase their issuers’ international visibility before international institutional investors. Also, the data of our partner exchanges is distributed via our data feed and thereby received by more than 200 data vendors who further distribute them. In addition, we are cooperating in the index area. These measures are all drawing international attention to our four exchanges. To make market access easier, we are currently implementing a common trading platform, starting with the Ljubljana Stock Exchange. Budapest and Prague are to follow in the future.”
But asked whether the group had actually agreed to adopt Xetra and Eurex for all its exchanges, the bourse is elusive: “The implementation of a common trading platform is a common goal of all CEESEG stock exchanges.”
So, is the CEESEG project a challenge for Warsaw?
Budapest is being diplomatic. “The CEE Exchange Group project for us is not a matter of challenging Warsaw, so much as trying to reach a better level for all of us than we had before, in terms of liquidity and international profile and exposure,” says Tóth. “There is a lot of room to develop our individual domestic markets, so it’s less a matter of rivalry with Warsaw than improving and developing the individual countries and the CEE region as a whole as financial markets.”
Asked if there was any prospect of cooperation between Warsaw and Vienna, Ludwik Sobolewski, CEO and president of the Warsaw Stock Exchange, says: “I did talk to my colleagues at the Vienna Stock Exchange and some cooperation would make sense, but so far it’s all talk and no deeds.”
Is Warsaw a competitor or a potential partner in the project to develop the CEE markets further?
Wiener Börse replies: “We do not see the Warsaw Stock Exchange as a competitor and we are interested in cooperating with the exchange. However, we are not holding specific negotiations at the moment.”
Asked what he thought of the CEE Stock Exchange initiative, Douglass Welch (pictured), director of emerging and western European equity derivatives at UniCredit in London, says: “Vienna clearly wishes to innovate, which is a good thing. But all those four markets have drawn very little new speculative interest so far, so we don’t see huge leaps in liquidity once the project gets off the ground.”
In his view, CEESEG might do best to liberalise, allowing smaller block-crosses and third party give-ups in derivatives, to attract smaller investors.
“Poland also suffers from this lack of flexibility,” Welch says. “The key to the CEE’s success will be to attract more domestic participants through the pooling of liquidity. Then more speculative liquidity would be attracted. The core product mix is adequate given our near term expectation of demand. There are ways to attract more retail customers, simply consider the success of listing ETFs in Vienna. As much as I’d like to see a huge uptick in activity, for the short term I just don’t see the international risk appetite required.”
Warsaw is dismissive. “The CEESEG is a linguistic thing, as all the markets
Asked if he saw the CEE Stock Exchange project taking off, one market participant says: “I’m quite sceptical about what value Wiener Börse can bring. Budapest hasn’t developed since Wiener Börse acquired it. Some market rumours suggest that players in Hungary are so unhappy with the Budapest Stock Exchange post-acquisition that they may start their own exchange.”
Asked for its view on these rumours, Wiener Börse responds: “In our view, the cooperation with our partner exchanges is very fruitful and strengthens the region as well as the local markets.”
Some investors seem to have decided which of the CEE champions to back.
“We’re very interested and involved in the developments in Warsaw,” says Welch. “For fundamental investors, Warsaw has a robust economy yielding good corporate dividend streams. Wig Index products and stock futures are certainly on investors’ radar, and there is quite a bit of opportunity for index arbitrage. The Polish story has attracted substantial interest from abroad. Poland is one of our top picks in the emerging European markets.”
He adds that derivative interest in the other CEE markets, such as Hungary and the Czech Republic, is more OTC, liquidity-driven and focused on stocks with the deepest liquidity.
Apart from being buoyed by the compelling ‘Polish story’, which attracts foreigner investors, Warsaw has other strengths.
“Warsaw certainly enjoys the first mover advantage,” in Welch’s view. “They have an active domestic user base – strong pension funds, which create consistent demand for all those IPOs of government companies about to happen on the WSE. Compared with ATX, CTX or the Bux, there are more users of Wig derivatives. However, the focus has been on futures rather than options, which are not yet as liquid.”
Wiener Börse, he says, “has a good diversified investor community, even if there’s a little bit of frustration over liquidity. There are a few large institutional players such as banks and insurers making use of hedging tools, but the retail sector is more ETF-focused.”
Already the most visible CEE exchange overseas, Warsaw’s IPO record has drawn notice, with the IPOs of insurer PZU and electricity company Tauron attracting attention earlier this year.
WSE’s own IPO is one of many privatisations lined up to feed the capital markets with investment opportunities.
As has often been said, Poland has taken to free capital markets since the end of Communism like a duck to water. Compared with some of its neighbours, it was also much slower to sell off its blue chip companies to foreign buyers.
Market participants cite the country’s large population, strong economy, domestic demand, and financial community as strengths of its derivatives market. Poland, some believe, has reached a depth and sophistication that give the market critical mass to continue on its growth path.
One begins to wonder if Vienna’s and Budapest’s claim that Warsaw is not their competitor may be due to the fact that Warsaw has already won.
“In terms of liquidity of the underlying, Warsaw has the lead,” says Welch. “Any development in accessibility, such as give-ups, will certainly be beneficial to trading growth. The Polish regulatory environment for derivative usage is evolving but remains more conservative than Poland’s western neighbours. But if you look at turnover and open interest, Warsaw is head and shoulders above Austria, Hungary and the Czech Republic, and I don’t see this changing any time soon.”
Ambition to be a ‘good monopoly’
The pattern could change in CEE. But on present showing, the CEE Stock Exchange Group remains an umbrella covering four very limited, mostly domestic exchanges with little further reach than their shallow domestic liquidity pools.
To the north is the larger and more vigorous Warsaw exchange, which also has ambitions beyond its own borders.
“I don’t think of Warsaw as a national exchange,” says Sobolewski. “It’s doesn’t adequately reflect the nature of our business, which is not contained within our national borders. The very term sounds archaic when applied to Warsaw, but there are certainly purely national exchanges in the CEE region.”
In fact, when it seemed that the IPO markets would remain closed, Warsaw was in talks with Deutsche Börse over a trade sale last year, but only under the condition that its strategic vision would remain intact. The Germans declined – the deal fell through.
Far from being just a Polish champion, Warsaw sees itself as the emerging heavyweight that will sweep up everything between Frankfurt and Moscow.
“Our strategic scope is much wider than just CEE,” insists Sobolewski (pictured). “We are also looking at the Ukraine and Belarus, which are two of our most important regions. All of the regions we are looking at have inefficient capital markets, and we are aiming to offer everything that’s interesting in the whole region under one roof – ours.”
The Wig 20 Index Future, which a market participant calls “a good product”, is the fourth most actively traded equity index future in Europe. The exchange says it has the broadest product range in CEE, and that it sees many advantages of having all markets such as equities, bonds and derivatives under one roof.
Next steps include a systems upgrade backed by its technical partner NYSE Liffe. Then the exchange plans to tackle the options market.
Rather than cooperating with other exchanges in the region, Warsaw’s strategy is to approach CEE companies and persuade them to list in Warsaw.
So far, 23 foreign companies are listed on the WSE’s Main Market and three on NewConnect, two of which are from the Czech Republic, and one from Bulgaria.
“Our aim is for NewConnect to be the ‘go-to’ exchange in CEE for all CEE companies and entrepreneurs seeking to list their companies,” says Sobolewski.
The strategy of outflanking foreign exchanges and taking their business doesn’t seem to allow for much cooperation between CEESEG and Warsaw. “Frankly, the more Warsaw succeeds in their vision, the less chances the CEESEG project has for success,” says one source.
And Warsaw doesn’t raise any objections to this analysis. In Sobolewski’s view: “Good monopolies are, for lack of a better word, good.”