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Information Services Boost Exchange Valuations

Exchange stocks are the currently the most attractive area of financials and their long-term value will be driven by information services according to analysts at German financial services group Berenberg.

Berenberg analysts Chris Turner and Panos Ellinas said in a report that volatile financial markets favours exchange stocks, at least on a relative basis, so investors should remain overweight the sector.

“We expect the mix of capital destruction in the near-term and slower economic progress in the medium term to slightly slow the earnings growth next year of the exchange stocks that we cover,” said the report. “With no operational disruption, strong cash generation and no exposure to credit or underwriting activities, the exchange stocks are, in our view, the most attractive area of financials right now.”

Berenberg reiterated their Buy rating on London Stock Exchange Group and upgraded Intercontinental Exchange to Buy.

Kyle Voigt, an analyst at financial services boutique KBW, said in a report last month the share prices of exchanges could continue to outperformance if the risk-off trade and high volumes continue.

Voigt said that US exchanges –  Intercontinental Exchange, Nasdaq, CME Group and CBOE – had outperformed the S&P 500 index by 10.4% since 19 February. In addition, European exchanges had outperformed their relevant benchmarks by 5.5% over the same time period.

Increase in volumes

In the short-term exchanges have benefitted from a spike in trading volumes across the majority of asset classes in the first quarter of this year as volatility increased. For example, the Berenberg analysts noted that equity index volumes at Deutsche Börse jumped by 58% year-on-year; interest rate swap-clearing activity at London Stock Exchange Group rose by 26%; ICE’s energy derivatives increased by 57% and CME’s suite of US Treasury futures grew by 36%.

“To the industry’s credit, this step-change in activity was smoothly handled by the existing trading infrastructure,” added Berenberg.

In Europe last month equity average daily trading rose 94% year-on-year , corporate bond trading increased 31% and foreign exchange trading rose 61%  according to a report from the Association for Financial Markets in Europe.

“The rapid increase in securities trading and post-trade activity has been carried out without any major disruption from a business continuity perspective,” added AFME.

In addition, issuance of investment grade corporate bonds surpassed €50bn in the first week of this month which was the highest weekly amount ever issued in Europe. In contrast, initial public offerings on European exchanges has declined 83% compared to a year ago according to AFME.

The European exchange-traded fund industry also had record outflows last month due to the coronavirus pandemic.

Detlef Glow, head of EMEA research at Lipper, said in a report: “The European ETF industry faced estimated net outflows for March (€3.2 bn) which marked the highest outflows in the history of the European ETF industry.”

Information services

The Berenberg analysts continued that derivatives are better placed than cash products in the medium term.

Over the long term, the analysts expect exchanges to benefit most from the recurring, compounding revenues generated by information services activities.

“These activities remain well positioned to deliver structural growth, regardless of cyclical market trends,” they said.

Theodor Weimer, Deutsche Börse

For example, Deutsche Börse said in its 2019 results call that it wants to make acquisitions that can add capabilities to its analytics and index division which was formed last year. In September last year the German exchange group created Qontigo as a new company through combining index businesses Stoxx and Dax with Axioma, a company it had acquired in 2019 and which provides tools for portfolio construction and risk analytics. Deutsche Börse said Qontigo can address trends that are reshaping investment management including the growth of passive investing and smart beta and the modernisation of the investment management technology infrastructure.

London Stock Exchange Group said in its 2019 results call that the acquisition of Refinitiv will accelerate the group’s growth strategy of becoming a leading global financial markets infrastructure provider; increase its global footprint; and add data, analytics and multi-asset class capital markets capabilities.

David Schwimmer, LSE Group

David Schwimmer, chief executive of LSEG, said on the results call that detailed integration planning is underway and the exchange remains on track to close the transaction in the second half of this year. He continued that the group is actively engaging with EU competition authorities who are reviewing the deal. “There are no surprises,” he added.

Information services revenues

Exchanges have seen significant growth in their information services revenues from just over $1bn (€890m) in 2005 to more than $6bn last year according to a study, Exchanges and Market Data: How Much Money Is Being Made?, from consultancy Opimas.

Octavio Marenzi, Opimas

Octavio Marenzi, Opimas

Octavio Marenzi, founder and chief executive of Opimas, said in the report: “The profitability of market data at exchanges is impressively high, and we estimate that exchanges are able to achieve an average operating margin of 76% in this line of business, significantly higher than the rest of their activities.”

He continued that exchanges’ profit margins are more than twice as high as market data vendors such as Bloomberg or Refinitiv, and more than three times as high as large investment banks.

However regulators in both the US and the European Union, are increasingly looking at exchanges’ market data revenues.

“They are preparing significant changes to regulation and market structure that will see exchanges’ market data revenues come under pressure,” warned Marenzi.