Third Time Lucky for Deutsche Börse and LSE ?
On Saturday evenings in England you can still watch repeats of Dad’s Army, a sitcom about the British Home Guard during the Second World War that was originally broadcast between 1968 and 1977.
This week we are watching the third repetition of an attempt to combine Germany’s Deutsche Börse and the London Stock Exchange Group. The two companies confirmed in a statement that they are in detailed discussions about a potential merger of equals.
Their first try was in 2000 when they announced plans to form a rival to Euronext, the pan-European exchange in Paris, Amsterdam and Brussels that had launched earlier that year. This deal was scuppered by an unsuccessful hostile takeover bid for the LSE from Sweden’s OM Exchange. Deutsche Börse tried again in 2004 when it bid for the LSE but was officially rejected in 2005, when the LSE also held talks with Euronext.
In November 2005 the UK Competition Commission published its decision to allow either Deutsche Börse or Euronext to acquire the London Stock Exchange but each party was required to give undertakings to implement a package of structural and behavioural remedies to ensure the independence of LSE’s clearing provider, LCH.Clearnet.
The decision said the proposed acquisition of LSE by either exchange would substantially lessen competition as it would make it more difficult for other exchanges to compete with LSE in trading UK equities due to both bidders’ direct control or influence over the provision of clearing services.
The Competition Commission said: “These behavioural commitments seek to reinforce the independence of LSE’s clearing provider by addressing the residual influence DBAG or Euronext may retain once the structural remedy has been implemented. These include commitments by DBAG and Euronext not to obstruct access to LSE’s clearing provider by any potential competitor to LSE, and to provide users with greater influence over any decision concerning a change of clearing provider.”
The situation has changed as the LSE acquired majority control of LCH.Clearnet in 2012and it has been a key objective to develop post-trade capabilities, especially in clearing.
Neil Cuninghame, competition partner at law firm Ashurst, said in an email: “In order to decide whether a similar conclusion is merited today, the CMA (or European Commission if the deal qualifies for notification under the EU Merger Regulation and is not referred back to the CMA) would need to re-assess the deal on the basis of the current market conditions by reference to not only clearing services, but also equities trading, derivatives trading, settlement services and other relevant markets. In so doing, the CMA/Commission will need to take account of the fact that the LSE now owns 57% of LCH.Clearnet. This acquisition was itself cleared by the Office of Fair Trading in 2012.”
Cuninghame continued that Deutsche Börse was prohibited by the European Commission from acquiring NYSE Euronext in 2012, but that primarily reflected concerns related to European financial derivatives where the Commission found the deal would have created a quasi-monopoly. “Concerns relating to financial derivatives seem less likely to arise in a DB/LSE merger,” he added.
The new regulatory environment since 2008 has made clearing even more critical as regulators have mandated clearing for over-the-counter markets and LCH.Clearnet’s SwapClear dominates the market for interest rate swaps.
Steve Grob, director of group strategy at Fidessa, said in blog: “The LSE has done a great job under Xavier’s stewardship of positioning itself for the practical realities of the industry today,which are all predicated on the premise of being efficient rather than merely being effective. This extends right through the trading process, and so teaming up with its German competitor makes perfect sense. Between them they would have around 40% of total European equities trading volume and, more importantly, the precious liquidity and open interest of Eurex to pour into LCH.Clearnet and soon to be launched CurveGlobal [the LSE’s new interest rate derivatives venture].”
Regulators have made capital more expensive, and banks have been shrinking their balance sheets, so participants will welcome the opportunity to net margins between LCH.Clearnet and Deutsche Börse’s CCP, Eurex. Eurex already allows default payment netting across cash equities, cash bonds, listed and OTC derivatives plus repo and securities. However a merger would also intensify the worries that already exist over the concentration of risks in CCPs and a decrease in competition leading to higher fees and member contributions.
The London Stock Exchange has supported open access to clearing with clients being able to choose where to clear transactions that are executed on its venues. In contrast Deutsche Börse has opposed open access and trades have had to be cleared through Eurex. In order to maintain a competitive market it would surely make sense for regulators to ensure that the merged entity allows clearing access to rivals ? In addition maybe Deutsche Börse should spin-off Clearstream, its international securities depository ?
This year Dad’s Army has been updated with a film version being released in the cinema. Despite critical panning, the film has been a box office success. The new version of the merger will have a harder task as the deal needs to please shareholders, sellside and buyside participants, regulators and most importantly, the competition authorities. Their review will be critical.
Phase 5 of the uncleared margin rules (UMR) took effect from September 2021.
Temporary equivalence is set to expire on June 30 2022.
IRS trading volumes have fragmented without an equivalence agreement.
Phase 5 of the uncleared margin rules came into effect on 1 September.
Triparty repos can be executed across U.S. Treasury securities to central clearing.