The LSE/Deutsche Boerse is back on investor’s radar this week as the 22nd March deadline looms for the two boards to tie up some of the loose ends around a potential deal.
While this isn’t the first time the LSE has been in the spotlight as a takeover/merger target, with the NASDAQ interest over 10 years ago, the TMX merger five years ago, and the fact that Deutsche Boerse (DE:DB1Gn) has also previously looked at the potential for a tie-up on a number of occasions since the turn of the century, the outcome of these talks could have significant consequences for London’s future as a centre for clearing in the coming years.
While investors appear to like the prospect of a deal given the recent rise in the share price, there could well be some problems when it comes to regulatory scrutiny.
It’s not hard to understand the appeal of an asset that last year contributed to 72% of the European IPO market due to London’s appeal as a centre for private equity and hedge funds, which makes the acquisition of LSE an attractive proposition given that raising capital is so much simpler in a very confined geographical location.
While some have expressed concern that the upcoming “Brexit” referendum could undermine the deal, it’s not immediately apparent that would happen, and in fact the prospect of it happening could increase the odds of the deal going through.
This is because it would provide the perfect excuse for EU regulators to encourage the slow dilution of business away from London given it would then be considered to be outside the EU, and as such, much more difficult to regulate with respect to euro denominated derivatives. This would be likely to happen even if the UK votes to stay in, so let’s not kid ourselves whatever the “Remain” camp might say, but any out vote would likely hasten such a process, given the ECB’s attempt to engineer such a process failed at the European court last year.
Management of Deutsche Boerse and LSE have gone to great lengths to point out that the synergy for savings could be significant in a so-called “merger of equals” as they point to potential savings of $5bn, and this may well be true, but it still presents a problem from a competition point of view.
While both bidding parties having clearing businesses of their own and the integration of Clearnet into Eurex could potentially offer huge savings with a one size fits all clearing house for their clients, this would mean that the combined entity would have a virtual monopoly on pricing in a single pan European exchange.
Aside from the possibility that London could see a lot of its clearing business leak over to Frankfurt, the fact remains that in 2012 the EU Commission blocked a similar type of deal between NYSE Euronext and Deutsche Boerse on the basis that the combined businesses would dominate Europe’s on-exchange derivatives with an estimated 93% market share.
If the European Commission had concerns about a monopoly between NYSE Euronext and Deutsche Boerse then it is hard to imagine they won’t have concerns about a Eurex/Clearnet situation, which would mean an almost total monopoly on clearing derivatives in Europe.
As with everything with respect to financial markets, politics is likely to play a part here given the current debate surrounding a potential “Brexit” scenario, in which case we could see a situation where the European Commission waives through this merger on political grounds as opposed to competition grounds, which in the long term could well lead to competition disadvantages as well as London’s disadvantage.
It will be interesting to see how this plays out, and the banks will have a large part to play in this story given that the banks own a large stake in the Clearnet business, which means that they could well have a big say in the success or otherwise of any potential deal.
While costs savings could swing the debate in the short term, the long term prospect of a monopoly on pricing could well give some banks pause on the longer term advantages of any deal.
With the deadline for Deutsche Boerse fast approaching on the 22nd March, any announcement could well trigger a counter bid from ICE as well as CME, who remain keen to get a bigger foothold in the European derivatives market.
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