Merrill Lynch Lambasts London Exchange Over SEAQ Rule Changes

Merrill Lynch & Co. last week attacked recent rule changes announced by the International (London) Stock Exchange, claiming the moves amount to closing the door to foreign competition and restoring "the old oligopoly" that dominated the market before the Big Bang deregulation in 1986.

In a Feb. 28 speech to the Association of Corporate Treasurers in London, Merrill Lynch Capital Markets vice-chairman John G. Heimann said the changes -- announced early last month -- "appear to owe their origins more to an attempt to re-establish the old oligopoly that prevailed under the former stock-jobbing regime than any effort to improve the competitively efficient workings of the system."

The ISE declined to comment on Heimann's remarks, but said it was "very doubtful" that the exchange would answer his call for "a good deal of further analysis and consideration" of the changes. Instead, it maintained that the rule changes are aimed at increasing visibility, tightening security and easing trade publication requirements.

The changes were published in an interim review of the market begun last December and scheduled for completion on March 31. In announcing the changes, Nigel Elwes, chairman of the exchange's domestic equity committee, said that "recent experience highlighted the need for urgent action." He was referring to the harmful narrowing of spreads last autumn and the increasing tendency toward off-exchange trading caused by publication of large transactions.

The interim report's recommendations called for three basic rule changes. The first -- the abolition of market-makers' obligation to make firm prices to each other -- went into effect Feb. 13. On Feb. 27, the exchange also introduced part of the second new rule, governing reporting of transactions in actively traded alpha securities to the Stock Exchange Automated Quotation system. Start-up dates for further changes affecting less active beta securities and the third rule change, which covers publication of trade details on Topic, have not yet been decided.

In his speech, Heimann said the London market was now "in danger of eliminating or downgrading the very principle of transparency on which the supposedly level playing field of the ISE was created; and losing the broad-based liquidity that is so vital to the system." He warned that "if these so-called reforms drive many existing market-makers to turn their attention elsewhere, the forecastable result will be a diminution in the interest of global investors in U.K. equities."

The new rule dropping market-makers' obligations to make firm prices to each other has been a cause of concern for many non-UK houses ever since its introduction. Until then, market-makers were obliged to offer firm prices in the stocks they trade in to all other ISE member firms. Under the new rule, market-makers can refuse to be firm with other market-makers or their brokerage affiliates.

The change is aimed at boosting market-maker confidence by reducing the risk exposure of firms taking large positions. In the past, rival firms have been able to balance their books by off-loading blocks of securities on market-makers in those particular stocks. But the rule change opens a threat to foreign firms, particularly U.S., Japanese and Swiss firms, many of which entered the London market through acquisitions of domestic players. These institutions believe they could be excluded from the market by the new rule, which unashamedly places the emphasis back on the U.K. broker-dealers.

"Why should those firms, who feel themselves effectively excluded by these reforms, commit their resources to extensive research coverage of U.K. companies?" Heimann asked. "Instead of adding resources dedicated to the support of U.K. industry, they will reduce their attention and seek profit-making activities in other markets." Indeed, it has been suggested that securities firms from fellow European Community member states, such as France and West Germany, are welcoming the moves, which they perceive as being detrimental to London's bid to become the major financial center in the European time zone.

Heimann also said that alterations to the rules covering the reporting and publication of transactions would not only undermine the transparency of the market, but would also impair the derivative markets by obscuring the true prices of the underlying securities on which those markets are based.

The exchange now allows players to report transactions in alpha securities exceeding 100,000 pounds sterling as much as 24 hours after the trade is completed. The change is intended to protect bigger players from exposure at the top end of the market.

Meanwhile, at the opposite end of the scale, the exchange aims to begin disseminating details of trades in beta stocks on its Topic service. Under the new ruling, the ISE will publish beta stock trades of less than 50,000 pounds sterling in a bid to boost visibility and protection for small investors.

The exchange's final rule change aims to cut the reporting time for transactions in all alpha and beta securities to 90 seconds from the current five minutes. The ISE plans to implement this in stages, with the first requirement calling for a three-minute time limit. So far, no date has been set for implementation of this new rule.