Exchange monopolies, massive retail trading aspirations and corporate scandals: Deutsche Boerse CEO to face huge grilling

Germany is a vast nation with a population greater than that of any other European country, and with extremely influential political sway, usually in the direction of socialism and with aspirations of controlling the outcome of major decisions that come from the equally socialist European central government in Brussels.

Despite Germany’s might and size, it does not have a place on the world stage of modern electronic financial markets, its industry being mostly legacy manufacturing and an inability to modernize. Political wrangling in mainland Europe reached the proposed merger between Deutsche Boerse and the London Stock Exchange, which, at £21 billion, was intended to create a merger of equals, but in fact has been fraught with dissent, inability to come to terms with London Stock Exchange’s potential control from Central Europe, and a deep-seated concern that a vast monopoly would be created.

Deutsche Boerse, which has got its eye on the London Stock Exchange and has had aspirations of moving the head office of the newly merged exchange marketplace to Frankfurt much to the extreme dismay of many British institutional senior executives including Lord Myners whose concernse, along with those of other senior London officials with lifelong careers in the exchange traded derivatives sector in the largest financial center in the world were ignored by Germany.

By the middle of last year, a report by the anti-business and staunch socialist European Commission whose interests are anti-British was generated to stifle a potentially harmful merger which would have placed the control one of London’s fine institutions in Frankfurt, which has about as much credibility in the world’s financial markets and electronic trading stage as a pre-packed sandwich from a vending machine would have at a French cheese and wine festival.

Tomorrow, Carsten Kengeter, CEO of Deutsche Boerse, is due to face an extremely harsh grilling in a ‘questions and answers’ session from market analysts, investors and media moguls in the advent of the release of its annual report for 2016.

The venue made an increase in net revenues by 8% during 2016 compared with the previous year, and its operating profit increased by 18% however the traditional derivatives exchange is embroiled in insider trading scandals and also has been taking a viscious look at how to, along with the London Stock Exchange should the merger go ahead, avoid any accusations of creating a monopoly, whilst actively position itself as a factor in the lobby toward forcing retail business onto exchanges.

Deutsche Boerse’s board has given its backing to Mr Kengeter, who is accused of buying shares in the company in December 2015 in the knowledge that a proposed tie-up with the London Stock Exchange was on the way.

However, Spiegel magazine reported at the end of last week that Mr Kengeter had spoken about a possible deal with Lars-Hendrik Röller, an economic aide to Chancellor Angela Merkel, in November 2015.

Mr Kengeter, who is due to become chief executive of the combined stock exchange, is also likely to face questions about the legal headquarters of the combined entity, which under the terms of the deal will be in London.

FinanceFeeds has been privy to information during the course of the proposals to merge the two venues that as a result of research by the European Commission, a merger would create the world’s largest margin pool with a value of 150 billion euros, therefore could impede competition for smaller trading venues that rely on LCH.Clearnet as well as other firms that offer similar collateral settlement services.

Germany. The non-entity that wants complete power

On that basis, London Stock Exchange’s response was to make a quick attempt to sell LCH SA in order to address proactively any anti-trust concerns. LCH Group which holds the European subsidiary LCH SA is 57% owned by the London Stock Exchange, with the remainder being owned by other users of the service.

It is ironic that the concerns of Lord Myners and other senior London officials with lifelong careers in the exchange traded derivatives sector in the largest financial center in the world were ignored by Germany, and that it has taken a report by the anti-business and staunch socialist European Commission whose interests are anti-British to stifle a potentially harmful merger which would have placed the control one of London’s fine institutions in Frankfurt, which is absolutely nowhere on the world’s financial markets and electronic trading stage.

The desperation that had now come about by the end of last year had been sensed by Euronext, which was one of the key suitors for the purchase of LCH SA, for which London Stock Exchange wants £430 million, and has to sell it in order to put paid to the investigation into any potential anti-competitive nature of the proposed deal, and quite frankly to just get on with it.

In late October, JPMorgan Cazenove was enlisted to oversee the sale of LCH SA, and all looked set to head to market and find a suitable acquirer, with Euronext being in the lead because it contributes around half of the revenue of LCH SA in clearing business from France, Holland, Portugal and Belgium.

Euronext appears to realize its position of strength in that it is strategically and operationally the most suitable acquiring party, and the shortlist of alternatives that would buy LCH SA is dwindling, however, Euronext has made it clear that it will not pay one penny for LCH SA. FinanceFeeds that this in itself represents a cartel in that clearing across all electronic trading via these two entities will become intertwined.

Therefore, even if this deal goes ahead and is not a cash transaction (the terms have not been agreed yet) it would not matter if LCH SA was given to Euronext for free, as it would remove the one obstacle that is in the way of London Stock Exchange and Deutsche Boerse creating a massive margin pool whilst their perceived moves toward lobbying the FCA to restrict the core business activities of OTC participants makes for an effortless sweep in which the entire business can be moved to their books.

Deutsche Boerse has had OTC FX in its sights for some time, one example being the acquisition by Deutsche Boerse in July 2015 of FX trading platform 360T for $796 million.

FinanceFeeds is also aware that this has been a focus for Deutsche Boerse for some time. Back in 2011, Deutsche Boerse took a minority stake in British FX technology solutions provider Digital Vega which was a technology vendor to buyside and sellside firms in the OTC derivatives sector.

At that time, the idea was to increase Deutsche Boerse’s positioning in the provision of pre-trade price transparency in the derivatives area for institutional investors and taking an initial footprint in the FX derivatives space. An investment agreement was signed last week, whereby Deutsche Börse will pay a US dollar amount in the single digit million range.

Thus, this interest is quite clearly part of the overall strategy, and with the sale of LCH SA to one Euronext which serves the purpose of removing the EU concerns about monopolies, yet serves to empower the listed derivatives industry just as much as if it was retained, the strategy is laid out for the year ahead.

Several politicians in the state of Hesse, where Deutsche Boerse is based, have refused to accept anything other than moving the headquarters of the newly merged entity to Frankfurt, and Thomas Schaefer, finance minister in Hesse, recently said it was “crystal clear” after the UK Brexit vote that this HQ should be in Frankfurt.

A less than credible venue would be one located in Frankfurt rather than Paternoster Square, in terms of infrastructure, participation in institutional financial markets globally, and in terms of talent and alignment with key venues in Asia and North America. Quite simply, central Europe is a backwater by comparison, and hampered by bureaucracy, debt and lack of dynamism.

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 merger, as he was appointed Chair of Governors at the London Stock Exchange in 2014.

In particular, Baron Paul Myners CBE, along with senior regulators in London, have 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.

Undercaptalization

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.

The incumbent Chairman of the Treasury Select Committee Andrew Tyrie has been on the fence for some time regarding the potential British exit from the European Union, however he has been vocal regarding the standardized EU regulations across all industry sectors, stating that there is absolutely no reason to fear a standard EU ruling on all industry matters. Indeed, Mr. Tyrie’s perspective on this matter is evident here, as he does not fear the potential difficulties which could arise from a merger between Britain and Germany’s flagship traditional exchanges, as it would appear to be manageable via standardized regulation.

However, if something does go awry and hand-wringing occurs between German and British regulators, then the effect on the Square Mile could be potentially vast. On this basis, politics should be left aside in favor of business acumen and suitability for purpose.

Seasoned London-based critics including prominent City journalist Alex Brummer, author of several books including “The Crunch” which looked closely at the reasons behind the 2008 credit crisis, have regaled indications from regulators that the sentiment within the offices of the authorities is that the merger proposals between London Stock Exchange and Deutsche Boerse have taken place over ‘cosy tea parties.’

London Stock Exchange acquired Borsa Italiana in 2007, during which time FinanceFeeds CEO Andrew Saks-McLeod spoke to then incumbent London Stock Exchange CFO Jonathan Howell at the London Stock Exchange’s then-new Paternoster Square headquarters.

At that time, Mr. Howell explained that, whilst time consuming, the acquisition was indeed that – a pure acquisition in which London Stock Exchange would become the owner of the Italian stock exchange, making its corporate decisions from London, a far easier way to manage a large entity, however with the uncertainty of future cross-border regulation in the advent of the Brexit, and an ‘equal’ merger between a British and German exchange, governance may well be somewhat different.