A Tale of European Market Unity: part two.

You may recall that recently I wrote about the proposed merger between the London Stock Exchange (hereafter the LSE) and Deutsche Börse. I outlined the arguments which supporters of the proposed merger were putting forward, discussed their reasons for supporting the merger, and concluded that the political climate would make for an interesting context.

This story had been running since late February of this year, when both the 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.

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.

But interesting developments have occurred since my initial post on the subject, and I thought to share these in a post today. Remember, dear fellow Law students, this is a key area of interest in relation to commercial awareness.

Firstly, we had the announcement that the LSE and Deutsche Börse had reached an agreement in their proposed ‘merger of equals’. In a shared statement, the exchanges called the all-share transaction ‘an industry-defining merger.’ Carsten Kengeter, CEO of Deutsche Börse said, ‘as a combined group we will create a European player that will compete on a global basis.’

 However, we also had the news in conjunction with the announcement that there were competing bidders, including the owner of the New York Stock Exchange, Intercontinential Exchange (hereafter ICE). Shares in the LSE jumped nearly 9% to a record high of £29.14 in early trading after the owner of its New York rival said it was considering an offer for the company, subsequently sparking the prospect of a bidding war. Arguably, the ICE was unsettled at the prospect of a merger, given that such a merger would result in the creation of a European powerhouse which would challenge the American markets.
While the U.S. firm must have been aware it would face political and corporate pushback if it attempted to break up the European proposed merger, it would appear ICE  believed that LSE shareholders could have been persuaded by a higher offer. However, under UK takeover rules, ICE was required to submit a formal offer for the LSE by no later than the 29th March, something which did not occur. Deutsche Börse was required to submit a formal offer by the 22nd March, and it announced the agreement with LSE on the 16th. However, chief executive of ICE,  Jeff Sprecher did comment on the same day that:
“We have access to capital and an expectation by our investors and customers that we’re going to continue to evolve and grow and use those capital markets”

Which could be viewed as a subtle means of saying ICE has not exactly backed away just yet.

Now, ICE had been honing its arguments against the merger ever since declaring an interest in bidding for LSE soon after the news leaked of the proposed deal. This is unsurprising. After all, the merger would combine the LSE’s share trading operation with the German exchange’s Eurex derivatives business, creating the third largest exchange operator in the world in terms of stock market value. The arguments can be summarised as follows:

  1. Size alert: this basically focuses on how the potential combination of the two largest exchanges in Europe would dominate the equities trading and clearing markets, setting prices and dictating conditions to investors and companies. ICE supporters were prepared to argue that its combination with LSE would in fact be more pro-competition.
  2. Europe’s smaller exchanges: this argument followed the line that the newly established merger of equals would dominate over medium-sized exchanges, such as France’s Euronext. This essentially was an overt overture to the French government to challenge the Anglo-German merger.
  3. ICE’s deal would not be a ‘tax inversion’: there had been some floated suggestions that ICE would structure its offer as an inversion. Yet this a controversial scheme, one that allows bidders to lower their tax bills by essentially moving their domicile to the country of the target company. The U.S. government hates inversions and has tried to quash them. ICE insiders strongly emphasised the Atlanta-based company decision to not follow such a route.

In order to commence a bidding war and break up the deal -which, it must be noted, is favoured by both boards- ICE has to present a superior bid comprised mostly of cash, as Deutsche Börse is preparing to offer a mixture of cash and shares. Regulatory and political arguments will only come into play if the bids from LSE’s different suitors are deemed to be credible.

Intriguingly, the argument in relation to the smaller European exchanges evidently gained some traction regarding the French Euronext. French economic newspaper Les Echos ran a story saying Euronext was concerned about the news of a merger between Deutsche Börse and the LSE, stating that ‘Euronext seems as isolated as ever’. According to the newspaper, Euronext is considering possible self-defence strategies, including the option to reach out to other smaller stock exchanges in Southern and Eastern Europe, such as the Bolsa de Madrid in Spain. Moreover, Euronext was contemplating its own future in terms of a possible purchase. The newspaper noted the possibility that Euronext could itself be bought by another foreign stock exchange cannot be excluded, and reiterated that in 2014, the French stock exchange had established an objective of ensuring it would not be purchased by a foreign stock exchange.

Such concern and action is only the beginning of the road for the proposed merger. There are many political, financial and regulatory hurdles to contend with. Given the magnitude of the proposed merger, and the significant financial consequence of same, there will be many questions asked of both exchanges.

The public announcement of the agreed deal is merely the first step for LSE and Deutsche Börse. They will have to contend with Brussels regulators, national governments, shareholders, potential interloping rivals. They must persuade shareholders they will be an all-conquering global combination, whilst also easing fears among competition authorities about their large market share in several areas.

Oh, as previously mentioned, there is just that small matter of the UK’s EU membership referendum. Given that the deal, for all that it proposes to be a merger of equals, Deutsche Börse would actually own 54.4% of the merged holding company, compared with LSE’s 45.6%. There have also been efforts made by German politicians and businessmen to gain additional concessions, after there have been claims of a lopsided deal because the holding company would be based in London. Eurosceptic politicians will undoubtedly seize on the deal, and use it as evidence of the UK ceding power and authority to Europe. Unease among British politicians about the merger saw several Commons Treasury committee members suggesting recently that they will question executives.

And it is not just British politicians which will criticise the merger. There are growing concerns within the German political sphere, too. German politicians and businessmen are voicing their resistance amid fears that Frankfurt’s status as a financial hub will be lost, as the holding company would be based in London. The German exchange’s home district is also lobbying to retain the exchange’s head offices amid concerns about the  merged group’s shareholder base coming from predominantly English-speaking countries.

It will all make for an interesting few months, especially as we head closer to June. It is worthwhile to keep an eye on developments in this case, for the outcome will have financial and political consequences.

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