Deutsche Börse, LSE merger on track despite Brexit

28 July 2016. By Dafydd Nelson.

Fears that a Brexit might wreck a planned merger between Deutsche Börse and the London Stock Exchange Group have subsided — for now.

Executives at both exchanges probably celebrated this week when Deutsche Börse’s stockholders endorsed the deal, though regulators in Germany and Brussels are yet to have their say.

A little over a month ago, the transaction had been written off in some quarters. The UK had just voted to leave the European Union, sparking immediate concerns that shareholders would revolt and regulators would balk at a deal that would see the merged entity’s legal headquarters in London.

Since then, investors in the LSE have voted overwhelmingly in favor of the deal. But that result was never in doubt.

Whether shareholders in Frankfurt-based Deutsche Börse were still keen on the merger was an altogether different matter. A sharp drop in the value of sterling — the currency in which the LSE reports its earnings — raised questions about deal valuation.

— Marginal call —

Deutsche Börse originally gave its shareholders until July 12 to decide whether to tender their shares. The German exchange had also set a 75 percent required level of acceptances. It soon became clear that this target would be missed.

One day prior to the July 12 deadline, Deutsche Börse said it would give shareholders an additional two weeks to make up their minds and would lower the required acceptance level to 60 percent.

This week, Deutsche Börse announced that it had met the target. Just.

On Tuesday, the German exchange said that 60.35 percent of its shares had backed the deal. That level is expected to rise as shareholders who didn’t tender by the deadline are given another opportunity to do so.

The backing of both LSE and Deutsche Börse investors is a big boon. Executives on both sides now have a clear mandate to go full steam ahead with the merger.

Not that the companies have been anything but steadfast. On the morning of the Brexit vote result the companies had said they “remain fully committed to the agreed and binding merger terms.”

Regulatory resistance

But the backing of shareholders won’t end speculation that the transaction might collapse.

German authorities — including the state government of Hesse — are said to be uncomfortable with the combined group’s plan to base its legal headquarters in London. Regulators could yet stand in the way of the deal.

In response, Deutsche Börse has emphasized the role of the “Referendum Committee” set up by the two companies to analyze the impact of Brexit.

The panel, drawn from the boards of both exchanges, will make recommendations “to ensure that the combined group will meet all regulatory requirements,” Deutsche Börse said in a statement this month (see here).

Conceivably, the work of the committee will focus on what legal structures need to be put in place to placate regulatory authorities.

Post-trading wars

The main attention is now likely to turn to a European Commission competition review of the deal. Deutsche Börse and the LSE are likely aiming to file their deal in Brussels for assessment by the EU in a matter of weeks.

The EU watchdog is expected to scrutinize several aspects of the merger, including the combined entity’s power in clearing financial trades.

In particular, the commission will probably assess the merged group’s strength in clearing non-exchange traded derivatives, or “over-the-counter” financial instruments. The companies could also come under fire from industry participants.

The merger partners could point to strong and growing competition from Chicago-based CME Group, which lies in second place to the LSE’s SwapClear platform in OTC products in Europe.

They can also argue that Deutsche Börse’s OTC clearing arm, EurexOTC Clear, is small in comparison to both SwapClear and CME. Deutsche Börse and the LSE could say that their respective OTC clearing operations aren’t close competitors.

In that respect, the London and Frankfurt-based exchanges could claim that the deal won’t give them a much bigger pool of collateral in the OTC space.

Nevertheless, some stiff regulatory headwind can be expected.

	Eliot Gao