place under the rules and regulations of an organized market
and those where the trading takes place over-the-counter. The role of
the exchange is an important one as it provides not only facilities for
trading but also end users with a degree of comfort that such trading
is taking place in a regulated environment. From an operations point
of view the structure of the exchange will provide the clearing
organization and also the product specifications as well as essential
data for the clearing and settlement processes.
An exchange first and foremost must gain regulatory approval. Part
of that process will be to convince the authorities of the merits of the
market and the strength of the rules governing participation in the
market. The regulator grants approval in the UK by granting either
designated or recognized status, so we have Recognized Investment
Exchanges (RIEs). In the UK the following exchanges have attained
the status. These are:
- The London Stock Exchange
- The London International Financial Futures and Options Exchange
- The London Metal Exchange
- International Petroleum Exchange
- OMLX – The London Securities and Derivatives Exchange
- virt-X
- COREDEAL
- Jiway
Overseas exchanges, which are not under the control of the FSA but
where the FSA believes that their operation is such that it establishes
fair prices, are given the status of Designated Investment Exchanges
(DIEs). The status granted to an exchange has implications for
investment by fund managers and investors, as, in many cases, the
trustees for trading and investment would not approve an exchange
without a status.
The role of the exchange is fundamentally different when it is a
derivative rather than a securities exchange. The main difference is
that a securities or stock exchange is where a company lists its shares
or securities. This process of obtaining a listing is to raise finance by
offering shares to the public, including institutions, in the primary
market and then having those shares traded in the secondary market.
Rules govern the listing of a company’s shares. In the UK the listing
authority used to be the London Stock Exchange but it is now the FSA.
Once a company’s shares are listed, the exchange monitors the
trading activity in the secondary market and ensures that the
company is complying with the requirement to make available
information of material interest to investors and shareholders. The
information that a company must supply includes basic regulatory
and legal requirements. This will include the date of the annual
general meeting, production of the accounts, changes to board
directors, buying or selling of shares by directors, major acquisitions
or disposals that will impact on the company’s performance and
profit/loss account, etc. Any failure to comply with this will result in
the exchange suspending the company’s shares from trading. Equally,
if the company is going to make an announcement related to the
company’s activities then it may seek a temporary suspension of its
shares until the announcement is publicly made. Such instances
would typically be a rights issue or recapitalization announcement,
merger discussions, etc.
By way of illustration, an example of information of material interest
would be when a listed football club makes a major signing or sells a
leading player. The impact of the funding costs, cash receipts and
impact on performance are all likely to affect the share price.
This suspension of a company’s shares will also happen if, for
instance, a company’s share price moves significantly, indicating that
rumours are circulating about an imminent announcement. It will
also happen even if the company is unaware of any reason why there
should be unusual activity in its shares or share price. The exchange
or the company can suspend share trading and, from an operations
point of view, it is essential to have data about suspended securities
and also about any changes to the capital structure, dividends, etc.
A derivatives exchange, however, is very different. Here the products
traded are not those listed by companies to raise finance but are
products designed by the exchange. As we saw in other article, the
standardized futures contract was established by the Chicago Board
of Trade and standardized option contracts followed when the
Chicago Board Options Exchange was established in 1973. Today
these two exchanges are among the leading derivative exchanges in
the world. The exchanges traded in excess of 3.5 billion contracts on
a variety of products, each one designed by the exchange.
In general terms the role of the exchange is to:
- Gain regulatory approval
- Appoint a clearing organization
- Determine the rules and regulations of the exchange
- Establish the membership criteria
- Provide a trading mechanism(s)
- Supervise the trading activities
- Design products (derivatives exchanges)
- List products for trading (securities exchanges)
- Provide information
- Provide data on prices
Although individual exchanges are very different the above roles are
standard around the world. We can see how an exchange is structured
by taking as examples the London Stock Exchange and Euronext.
