Placing a stop on exchange mergers

The likely block of a merger between Deutsche Börse and NYSE Euronext highlights policymakers' unease with stock exchange consolidation and that won't change anytime soon.

It is possible to lump the European Commission’s looming recommendation to block the proposed merger of Deutsche Brse and NYSE Euronext – a deal that would form the world’s largest securities exchange – in with the string of similar failed stock exchange deals around the world last year.

On that interpretation the long journey towards consolidation of the world’s bigger exchanges has effectively ended because regulators have come to the conclusion that they don’t want any further concentration.

Last year, we saw the attempt by Singapore Stock Exchange to merge with the ASX blocked by Wayne Swan on national interest grounds, the London Stock Exchange forced to abandon its planned merger with Canada’s TMX Group after a parochial backlash and the emergence of a counter-bid from local banks and pension funds, and a hostile bid by Nasdaq OMX and Intercontinental Exchange for NYSE Euronext stopped by the US Justice Department.

In total, deals between exchanges that had a face value of more than $35 billion failed.

The attempted mergers were driven by similar motivations. Incumbent traditional stock exchanges have seen their market share, volumes and profitably undermined by new competitors and trading platforms.

Cash equities, the traditional staple for exchanges, are now a shrinking, low-margin, commodities product, causing a push into derivatives trading and creating incentives for mergers to extract synergies and drive down costs to enable the exchanges to compete with the new electronic platforms.

There is a particular reason, one which has no relevance to the failure of the ASX/SGX or TMX/LSE mergers, for the European Commission’s opposition to the Deutsche Brse/NYSE Euronext transaction.

If they merged, the combination of their derivatives businesses would give the new entity a near-monopoly on trading in some segments of European futures trading. It would dominate European exchange-traded derivative markets.

According to the Financial Times, the EC would allow the merger to go ahead if one of the derivatives exchanges were sold, but the companies aren’t prepared to contemplate that, presumably because it is the central appeal of the proposal. They have argued that the market for exchange-traded derivatives is global and that there is also competition from over-the-counter derivatives activity.

In any event, the EC position is driven by competition policy issues, as was the Justice Department’s opposition to the bid for Nasdaq OMX. Another concern about creating dominant derivatives markets is the potential threat to systemic stability in the event of a major financial crisis if most derivative trading is being cleared and settled within a single entity.

The ASX/SGX and TMX/LSE deals failed, not on competition grounds, but because of parochialism, the fear of a loss of sovereignty and some concerns, particularly in the case of the ASX/SGX proposal, about the potential for threats to the integrity of the local market and its clearing and settlement systems in the event of a financial crisis. Swan has stated that he isn’t opposed in principle to a merger of ASX and another exchange.

Since that merger was blocked, competition has been introduced to the Australian exchange-traded securities market with the launch of Chi-X’s platform. There are other ‘new age’ platforms interested in entering the market, too.

The ASX’s interest in the SGX merger wasn’t just about, or even mainly about, the value it would release for its shareholders, but was rather driven by its concerns that it would lose value and relevance in a more consolidated and significantly more competitive environment.

Even if the tide of global consolidation has now peaked, those concerns would remain. The tie-up with SGX offered synergies but more particularly would have linked ASX and Australia far more directly into the rapidly growing regional capital flows within Asia and would have produced a very powerful regional derivatives business. There was a fundamental logic to the deal beyond synergies and scale.

That logic remains, even if it is improbable that a link with SGX will be contemplated again any time in the foreseeable future, as does the increasing pressure being exerted on exchanges like ASX from the new platforms.

Whatever the logic, however, it is apparent that regulators and politicians don’t like exchange mergers of any real scale and import, whether it is for political reasons or on competition grounds.

The continuing financial crisis and its politicisation of anything to do with finance, the fear of derivatives and any concentration of activity in them, and narrow and arguably outdated definitions of the boundaries of securities markets make it unlikely that any merger of significance will get past them smoothly any time soon. The era of exchange consolidation and the notion of global exchanges may not have ended, but it does appear to have paused.

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