Euro changes pose threat for market

The decision by the London and Frankfurt stock exchanges to enter into an alliance to establish a Pan-European stock market is evidence of the rapid changes taking place on the European landscape. Meanwhile, the French stock exchange, miffed at being left out by the British and Germans, announced that they were going to create their own alliance. Whatever the eventual outcome it is clear that there will be a Pan-European stock market in operation geared towards the top 300 to 400 companies within a few years or indeed sooner.

The implication this will have for the smaller exchanges such as Ireland's is as yet unclear. Only a handful of Irish companies would be large enough to be quoted on a PanEuropean exchange and therefore most Irish companies will still require a local stock market quote. However, the emergence of more integrated European stock markets must increase the likelihood that more share dealings will gravitate towards the larger centres.

This must pose a danger that the Irish market will decline in significance over the coming years. There are many who will point out that despite the abolition of exchange controls in the late 1980s the Irish stock exchange has continued to thrive. A major factor in this is the fact that the best match for Irish pound liabilities is the Irish equity market. Pension funds, which must meet very long-term liabilities, have poured billions of pounds into the Irish equity market over the past 20 years.

The advent of monetary union will radically alter the opportunities facing Irish institutions. Investment in the founding EMU members will now involve no exchange rate risk.

Most Irish pension funds currently have 30 to 35 per cent of their total assets in Irish equities. Some commentators argue that this weighting will be progressively reduced to as low as 10 per cent. If this happens the only buyers of those equity stakes will be overseas institutions. As stock shifts from Irish hands to overseas, so is it likely that trading patterns will follow. This has already been seen in the large Irish blue chip companies where a significant portion of trading now occurs through the London stock exchange.

Of course Irish institutions may not reduce their stakes in Irish shares to the extent predicted by some of these commentators. Irish inflation and the rate of increase in wages and salaries looks as if it will be significantly higher than the European average in coming years.

Over the long-term general inflation rates throughout Europe should converge. However, there could well be prolonged periods where salary and wage inflation varies substantially among different countries. It is salary and wage inflation that pension funds are most concerned about.

The upshot of the above argument is that even in a monetary union Irish pension funds will still want to hold a substantial portion of their assets in Irish equities. The actual amount of funds committed to the Irish market by Irish institutions will in all probability be more a function of the investment opportunities available than on the somewhat esoteric arguments regarding the matching of longterm assets and liabilities.

In this regard the demutualisation of First Active, the privatisation of Telecom Eireann and the possible flotation of Cantrell and Cochrane will play an important role in sustaining the viability of the Irish stock exchange.

For private investors the movement towards a Pan-European stock market should bring many benefits. Currently, for private investors the costs of dealing outside of the Irish and British markets effectively involves a double burden. This is because an Irish broker will generally use a foreign broker to execute non-Irish and British deals and the additional cost will be passed on to the investor. In a Pan-European market there will only be one set of commissions to pay.

Furthermore, Irish investors in sharp contrast to their British counterparts, will be dealing in euros so that there will be no need to engage in costly foreign exchange transactions for most European shares. Therefore, private client portfolios are likely to move in a similar fashion to their institutional counterparts. The weighting in Irish and British shares is likely to decline over time while their weighting in the rest of Europe is likely to increase.

All of these shifts are likely to occur over a prolonged period. Furthermore, there will be countervailing shifts elsewhere leading to extra demand for Irish shares from European fund managers. Whatever is the eventual shape of trading in Irish and European stocks, it is certain that the new European landscape will provide a much wider array of investment opportunities to the private Irish investor.