LSE -Deutsche Börse merger: European Market Unity?

Regular readers may recall that I once wrote a ‘walkthrough’ post in relation to commercial awareness. I stated then that as a law student, I have read many articles and listened to many a presentation over the years pertaining to commercial awareness. It has been stressed that this is a vital, and necessary skill for aspiring lawyers. But I also stated that the term and what it denotes can sound vague for many students. So in an attempt to assist my fellow students, I wrote about commercial awareness, using the London Stock Exchange and its then-current woes (arguably still continuing woes) as my means to explain just what exactly is meant by ‘commercial awareness’.

Times Coffee

The story at the heart of this blog post today is again one tailor-made for students seeking to enhance their commercial awareness and understanding. And again, it focuses on the London Stock Exchange, and it promises to be an intriguing story which, if all plans proceed accordingly, would have a big impact not just within European markets, but in the global markets, too.

This is the news that the London Stock Exchange and Deutsche Börse are continuing in their merger talks for a new exchange. Discussions centre around the leadership team, and the corporate HQ for the new exchange – which could become the third largest in the world. If this isn’t a story of current commercial awareness interest, then I do not know what is.

This story has been running since late February, when both the London Stock Exchange (hereafter LSE) and Germany’s Deutsche Börse were forced to admit they were in talks after news of their discussions were leaked. It was then revealed that the pair were in fresh talks to create a so-called ‘European powerhouse’ via a staggering £21bn merger. Unsurprisingly, given the current European economic and political climate, this apparent ‘merger of equals’ is likely to be closely monitored by European politicians. This is especially true as we edge closer to the run-up to the EU referendum in the UK.

So, what are these two economic titans seeking to achieve in their third attempt to merge? It would appear that the two exchanges are aiming to unite in order to create a European powerhouse of trading in stocks, bonds and complex financial instruments. It also is hoped the subsequent established ‘European powerhouse’ would be able to take on rivals in both the US and Asia.

The two exchanges said they were embarking on a ‘merger of equals’ in which both companies would share control of the boardroom, and retain their separate brands. However, upon closer inspection of the proposed plans, they seemingly favour the Frankfurt-based stock exchange: Deutsche Börse would actually own 54.4% of the merged holding company, compared with LSE’s 45.6%. (So, a ‘merger of almost equals’, perhaps?) However, according to the Financial Times, the holding company would be based in London – which might go some way to soothing any lingering concern that the German exchange was gaining greater control of the business.

Stock markets are susceptible to announcements, and unsurprisingly there was a noticeable reaction after the news leaked in February. LSE’s shares initially jumped 17% to £27.06, valuing it at about £9.5bn, before closing 13% higher at £26.30. Deutsche Börse raced up 7% to €81.71, giving it a value of almost £12bn, before paring gains to end 3% higher.

Is it to be a case of third time lucky for this proposed powerhouse? Well, considering how the exchanges are still in talks,this would suggest there is a very real possibility that we could see a successful merger being struck. It must be noted that even if both exchanges reach a mutually agreeable deal, a number of issues will still need to be tackled. This includes potential questions from the competition authorities – which blocked a deal between Deutsche Börse and the NYSE Euronext back in 2012. In addition, regulatory approval would have to be sought from the two major City regulators, the Financial Conduct Authority and the Bank of England, so to ensure the enlarged entity was properly managed. And not to mention, this must be conducted against the backdrop of potential Brexit as a consequence of the summer EU referendum.

So, just how do the LSE and Deutsche Börse plan to persuade regulators and politicians not to obstruct their proposed merger? It seemingly comes down to one key argument: that Europe needs an ‘exchange champion’, a powerhouse resplendent with the ability to take on the US and Asian markets.

Okay, I hear you say, but what exactly does this mean? Fret not, allow me to elaborate.

 Supporters of the deal cite three reasons for this: economics, trade and politics. (See why I constantly reiterate the argument that politics, law, and business are entwined and influence one another?)

The economic argument is perhaps the easiest to push forward. It is submitted that European companies need to be able to raise funds on the capital markets at prices comparable to those paid by U.S. rivals. And currently, this is not the case. So, by creating a bigger venue for investors, companies and banks, the new group would help European companies pay less for their funds. At least, this is the theory. Whether it would be successful in practice is another story.

Regarding the trade argument – well, this one is subtler and more complex. The problem here is that Europe’s capital markets will simply remain sub-par compared to the U.S. and Asia.
In the American corner, the US already has two huge exchange operators: Chicago’s CME Group, and Atlanta’s Intercontinental Exchange – otherwise known as the owner of the New York Stock Exchange.
From the Asian corner – it is about to become a more prominent player. It already has Hong Kong’s HKE, but the real threat is the Shanghai SE. One of two independent Stock Exchanges in China, it is likely to only get become bigger and stronger as China opens up both its economy and currency globally. So, this trade argument essentially boils down to stating that Europe must have its own big player to compete with the aforementioned Eastern and Western rivals. And, as the argument goes, such a big player can only come from the merging of the LSE, and Deutsche Börse.

Finally, the political argument. This strand argues that by having a pan-European exchange infrastructure, the EU’s ambitions in capital markets may be realised. It could provide a perfect example of the benefits of the Capital Markets Union so often touted by the Commission, and compliment the other aspects of the single market. It should be noted the single market is taking a hit, given the general continuing struggles of the Eurozone generally as well as sluggish economies within individual member states. It doesn’t help matters that deflation has raised its gloomy head: consumer prices fell 0.2% in February, the first month of negative inflation since September 2015.
On one hand, such a deal as proposed by LSE and Deutsche Börse may just be what the single market needs to stimulate growth and investment. On the other hand, such a merger may be viewed by member states as proof that the UK and Germany are the dominant political players in the single market, which may not exactly go down well.

Now, as mentioned, this is not the first time such a merger has been proposed. The exchanges had first agreed to merge in 2000, before a rival bid for the LSE from Sweden’s OM Gruppen scuppered the deal, only to be rejected anyway. Then in January 2005, the LSE rejected a formal £1.3bn offer from Deutsche Börse.

However, the timing of this current proposal is better than those in the past – from a general EU perspective. Europe’s economy is craving a true single financial market. Moreover, there is a risk that the US and Asia will become key global players to the detriment of the EU, ultimately edging the EU out. From a UK perspective, however, the timing is awkward, for as previously mentioned, there just happens to be the same issue of the UK going to the polls to determine the future of the UK’s relationship with, and within Europe.

Should an agreement be reached this time around, it would mark yet another chapter in the complex history of the LSE. It has expanded beyond trading stocks and shares in London into owning the Italian stock market, and possessing a major stake in a clearing house which operates behind-the-scenes business to guarantee billions of pounds-worth of trading. The LSE’s history of mergers is not quite as illustrious-sounding, though. Four years ago it tried, but ultimately failed, to merge with an exchange in Toronto.

We shall simply have to wait and see whether it shall be a case of third time lucky for the LSE and Deutsche Börse. Nonetheless, this is both an intriguing and important story to follow. I cannot recommend keeping on top of current affairs enough to all law students. It pays to know what is going on in the world. Remember, events in one area e.g. business will have a knock-on effect in other areas, such as law and politics.

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