The deal is off! Regulatory concern over impact on derivatives markets halts LSE and Deutsche Boerse merger

London Stock Exchange’s acquisition proposals by Deutsche Boerse have been halted. We look at why the ‘merger of equals’ between two longstanding venues is anything but a merger of equals, and why London’s interests will always be upheld by the major names in the exchange traded derivatives sector

Paternoster_Square_from_St._Paul's_Cathedral

The extremely controversial internal wranglings between two unaligned stock exchanges – Deutsche Boerse and London Stock Exchange – have finally come to a grinding halt, putting a potential end to the proposed merger between the two traditional trading venues.

Germany’s Deutsche Boerse has been engaged in plans to acquire the 215 year old Central London pinnacle of listing venues for blue chip companies, with an offer of £21 billion having been proffered.

The discussions between the two entities, as well as the German and British authorities’ views on a potential merger have been heated to say the least, with British officials condemning it as far from the ‘merger of equals’ that the German potential acquirer claims it was designed to be.

Yesterday, the European Commission put the brakes on the deal by warning that the two companies could potentially elminiate competition in a number of areas including trading in the derivatives markets, an odd statement from a European central government department whose institutional venues cannot compete with those of London for market share, level of sophistication in terms of trade execution and proximity to the giants that power their markets.

The European Commission would have had to approve the plans to merge the two exchanges, and this would have been expected to take place at approximately this juncture, however in place of giving the go-ahead, the European Commission will now make an in depth investigation which is scheduled to last until February.

Many British senior figures are opposed to the sale of the London Stock Exchange, which is a prestigious part of London’s institutional financial markets economy, viewed as the crown jewles of the City, especially to a European rival.

Opposition on home territory surfaced some months ago, with several senior London regulatory officials and former City Minister Baron Paul Myners CBE having voiced their concerns over the methodology behind the proposed merger and demonstrating a disdain for any ceding of power to Frankfurt.

Lord Myners, who served as Financial Services Secretary to the Treasury between October 2008 and May 2010 under the Labor government of the time and has several senior executive positions behind him which were within large institutions including NatWest and RBS, as well as Lord Rothschild’s RIT Capital Partners where he serves as a board member since August 2010, has a vested interest in the proposed merger, as he was appointed Chair of Governors at the London Stock Exchange in 2014.

In particular, Lord Myners, along with senior regulators in London, has had for quite some time serious concerns relating to how clearing operations can be expanded across both exchanges.

According to laws in America and Europe, notably the Dodd-Frank Wall Street Reform Act and the EMIR (European Market Infrastructure Regulation), exchange-traded swap contracts must be cleared through specific electronic clearing houses, a process which engenders greater transparency and in the case of London Stock Exchange, its own subsidiary LCH.Clearnet is used for this purpose.

Surely, therefore, if any merger with LSE is to take place, it should have been with IntercontinentalExchange (ICE) which is one of Chicago’s most advanced electronic derivatives venues that shares values with LSE, however this was blown out of the water by Deutsche Boerse’s fierce negotiators.

The case in point here is that nowadays, with large banks better capitalized, transactions are now being passed to institutions with very little capital at all therefore if large trades went wrong, there could be massive exposure, and as a result, a question mark hangs over the corporate governance of a new entity consisting of the London Stock Exchange and Deutsche Boerse with its head offices in two separate countries, which could lead to a shirking of responsibilities by British and European regulators, or a degree of buck-passing. Counterparty risk is, after all, a very important subject post SNB EURCHF peg removal.

Germany’s push toward a relocation of the head operations to Frankfurt during the final stages of negotiations was a massive concern for British regulators and London Stock Exchange officials.

Such a move would remove it from its top quality heartlands and make LSE the potential subject of reporting of the post-merger group’s profits in Euros, with Deutsche Boerse CEO Carsten Kengeter becoming the head of the entire operations (!!!!)

In this case, shareholders of Deutsche Boerse would have a 54.5% stake in London Stock Exchange, making it more of an acquisition by Frankfurt’s main venue than an actual all-share merger, and that senior executives had previously stated that the new post-merger group would be based in London as a smoke screen in order to fend off pre-merger claims that the executives are acting against Britain’s national interest, especially as that particular statement was made in the advent of Britain’s potential exit from the European Union.

Manfred Zass, a former Deutsche Boerse director, warned the proposals could damage Frankfurt’s standing as it aspires to become a rival financial centre to the City, and several German politicians claim it is vital the company is based on the Continent – particularly as Britain dared to vote to leave the EU.

Germany is a highly political nation, and has been for a long time. A socialist and highly politically opinionated nation to be more accurate. A major financial markets and modern technology center it is not.

Business as usual in Paternoster Square then chaps. Tally ho.

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