Updates #6
Back up to speed on the Tel Aviv Stock Exchange
Held.
I’d be remiss if I didn’t include some kind of reference to the recent spate of Chris Hohn interviews. I’ve very much moulded my own approach, in part, off of TCI’s - at least the part where they bought great companies in unusual situations. While I’m sure the media appearances from the otherwise reclusive fund manager are not without an ulterior motive, there were a few nuggets:
Nicolai Tangen: Another group of businesses you’ve been very big in has been the stock exchanges. Both Deutsche Borsa and the London Stock Exchange… Why were they so good?
Chris Hohn: In the case of Deutsche Borsa they had a derivative business called Eurex that had a natural monopoly, it had a network effect which was the barrier to entry. Liquidity of the marketplace for trading bond futures, once you get best prices in a certain marketplace it has what would be termed a ‘winner-take-all’ or a ‘winner-take-most’ effect. Once you have that liquidity it’s very hard to move people away. You can’t compete on best price. London Stock Exchange has LCH.clearnet, a clearing business. CME has it on US futures…. These exchanges can be very good. They’ve changed now.
Luckily for the Tel Aviv Stock Exchange (TASE) it hasn’t materially moved away from the core network effect that Hohn described above… although it enjoys this competitive advantage in equities, government bonds, historically in Shekel options and now futures, and it has its own internal clearing business (which saw dramatic revenue growth this quarter). With a sufficient amount of new developments, we’re due for an update.
Broadly speaking, what has been happening in the wake of the company’s reorganisation post the “arrangement shares” situation (refer to my original poast), is a general programme of pricing normalisation (read pricing power) and just straight forward business development activities by management that have been aimed at bringing TASE up to date with its peers elsewhere in developed markets. While TASE had been a mutually owned organisation under the supervision of the domestic regulator for many decades, certain financial reforms pre-Covid allowed for it to become a publicly owned corporation.
A number of cluey international fund managers were able to secure large blocks of shares both pre-IPO and post-IPO (including Bill Ackman) and board seats that allowed for management to properly incentivised. The results have not been dissimilar to the many, many stock exchange demutualisation’s that have occurred before. Furthermore, the company has remained reasonably valued for most of its run as a public company allowing for a series of efficacious and timely returns of capital via repurchases and dividends. It is perhaps one of the best situations I have (completely on accident, mind you) come across in recent years.
What has made TASE something of an oddity, however, is simply the uniqueness of the assets its hold. As Hohn elaborated above, most of the exchange situations he had been involved with usually had one very good business hidden within the larger exchange business. TASE on the other hand has a collection of these. While this has been, and continues to be, interesting from an optionality perspective it’s encumbering with respect to analysis.
Exempting equity trading, which is well in line with international peers and has actually been experiencing pricing amelioration (god forbid!), TASE’s other business lines have been growing well above inflation irrespective of wider domestic or international economic and political environment. Much of the general commentary around TASE’s growth as a capital market has centred around dual listings of already publicly traded domestic champions, and TASE’s capacity to draw more equity listings generally. I don’t disagree that these are important elements to the company’s overall business but it’s been the kind of lazy, wide-eyed myopia that has ensured that the company has been consistently misunderstood (and maybe still is). The services TASE offers branch out much wider than just raising equity capital.
Much of the business’s growth has not required significant investment. Recent history has been an instructive in this regard.
Trading and clearing commissions
The traditional core of TASE’s business is in the trading of various financial instruments. Primarily speaking this in equities, equity derivatives, corporate and sovereign bonds, as well as currencies and currency derivatives (once options but now futures primarily), and soon to be futures on indices. Before we get into a discussion about how these break down in terms of overall transaction contributions to the business it’s important to stress how underdeveloped Israel’s capital markets are generally. For example, TASE was unable to charge commissions for things like OTC transactions as late as last year. The number of firms offering broking and clearing services to retail shareholders could once, in very short memory, be counted on one hand. Even large domestic pension funds had archaic mandates that precluded them from making even nominal investments in public equities. Modern, low-cost brokers, or even home grown online brokers either did not exist, or had never advertised to retail investors. Infrastructure that allowed for collocation didn’t exist until 18 months ago. More pressingly, TASE are in the midst of rolling out futures products for indices, while the Kessenet is currently in the process of passing new securitisation legislation. That is legislation that actually defines what securitisation is! I could go on.
In terms of products that drive TASE’s transactional revenue (we’ll get to non-transactional revenues later) these are broken down into five segments: 1). Derivatives, 2). T(reasury) Bills, 3). Government Bonds, 4). Corporate Bonds, 5). Stocks (excluding equity options which get counted towards derivatives). The trading in Government related debt instruments sits at about 4 times the annual volume of corporate bonds. Growth in these markets has occurred somewhat inversely to the general trends in equity trading.
Trading of financial instruments underlies TASE’s entire business: their Government appointed position as the singular forum for the entire gamut of public capital raising, and in turn trading, in Israel is the franchise. While successful exchange businesses come to pre-eminence by being the first to accrue sufficient liquidity in a certain kind of market for financial instruments, TASE is, by definition, the only game in town. Passage of the aforementioned legislation will make this a legal certainty. This isn’t to say that the private markets for business lending, sales, and the other forms of venture and subscale business investment won’t be competitive - they just won’t be able to offer the same things that exchange listed products can.
A number of key themes have been playing out over the last twelve months. First has been the amelioration in pricing across number of commissionable products. In large part this has been in mutual fund products, but also to some extent in derivates, stocks, and T bills. The former gets counted against traditional stock transactions. In truth most tradable products have been experiencing mid-to-low single digit percentage pricing reductions, ostensibly as certain clients exceed certain volume threshold numbers. These reductions have been considerably offset by increased trading volumes across the board.
TASE, in large part, holds a monopoly on the raising and trading of Israeli sovereign debt. Similar positions have been held in the past by likes of Salomon Brothers, and large merchant banks elsewhere in the world. As the war with Gaza, and related adversaries, has dragged on the Government of Israel has had to fund its increased expenditures with large amounts of debt finance. As of about 16 hours ago the IDF began new, on the ground operations in the Gaza strip. While the conflict has dragged out TASE has provided a vital service in the issuing of Government Bonds specifically, and consequently trading volumes have grew substantially. It is not surprising that TASE has found itself clipping the ticket slightly less as a result (certain volume thresholds incur lower commissionable rates, as is common across trading globally). Government Bond trading has been a welcome accompaniment to derivative and stock trading volumes which have faced muted demand for new issues over the last twelve month but consistent (now exploding) trading volume increases.
As a sign of things to come, in Q1 2025 TASE experienced as many new and secondary equity listings as in the entirety of 2024.
As a point of interest, since listing in 2019 TASE has seen trading and clearing revenue decline as a percentage of overall revenues (from 45% down to 38%) despite very healthy growth in overall volumes.
A number of important catalysts remain that will almost certainly lead to an increase in trading volumes over the foreseeable future. The first is simply the one that is has started to play out this quarter: a normalisation in the economic environment after the shocks that hit the Israeli economy in late 2023. In early 2024 there were significant liquidity outflows from the Israeli securities generally as the war began to pick up momentum. This affected certain other names I cover. As of the last quarter, however, optimism has returned to the Israeli economy generally on the back of strong projected GDP growth which should be fairly well insulated from wider global macroeconomic concerns.
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