LONDON, Dec 8 (IFR) - The European Commission is expected on December 13 to outline its objections to the proposed tie-up between Deutsche Boerse and the London Stock Exchange Group, according to people familiar with the matter.
Through an in-depth investigation that began in September, the Commission is addressing the firms’ stranglehold in derivatives markets. It is a concern that ultimately scuppered DB’s attempted tie-up with NYSE Euronext in 2012 and some fear that similar issues will put the proposed US$14bn acquisition of LSEG out of reach.
“The Commission has until March to rule on the deal but the general feeling is that it may already be dead in the water,” said one senior broking professional. “The derivatives monopoly isn’t the only problem, but it’s the one where it’s very difficult to see a solution.”
Research firm Morningstar assigns a 25% likelihood to the deal going ahead - down from 50% at the March announcement of the proposed deal as the UK’s vote to leave the European Union piled additional pressure on negotiations.
“As things have progressed, Brexit has had more of an influence and may have lowered the chance of the deal going ahead,” said Eric Compton, equity analyst at Morningstar. “Although it might not make much of a fundamental difference to the deal, Brexit means that the risks have become much more political.”
DERIVATIVES MONOPOLY The proposed tie-up would combine LSEG’s dominance in over-the-counter derivatives clearing through its LCH subsidiary with DB’s Eurex, which has a leading position by volume in exchange traded derivatives. LCH’s SwapClear has US$279trn outstanding in cleared interest rate swap notional, representing 95% of the cleared swap market.
For regulators, the biggest stumbling block is the combination of listed and OTC liquidity pools through portfolio margining, enabling clients to net swaps and futures exposures.
“Swaps and exchange-traded interest rate derivatives historically had separate ecosystems with liquidity pools that weren’t linked up, but times have changed,” said Giles Edwards, analyst at S&P. “With more portfolio margining between swaps and rates, a tie-up between the two leaders could in theory be seen as creating a single dominant provider in clearing. But this would mean the Commission backtracking on its previous ruling that the two markets are separate.”
Any chance of a regulatory U-turn remains low but it might not be inconceivable given the threat posed by larger US exchanges such as CME and InterContinental Exchange, which have aggressively expanded in listed markets and OTC clearing.
LSEG and DB are much smaller than their US rivals and a merger may be the only option for a European provider to compete globally. The combined market capitalisation of the two European groups stands at US$27bn-equivalent - two-thirds the value of CME and three-quarters the value of ICE.
TOKEN SALE Plans by LSEG to hive off Paris-based clearing arm LCH SA may be little more than a token in addressing competition concerns. The French platform houses credit default swap clearinghouse CDSClear, but volumes remain low. Just over 900bn gross notional of index and single name CDS contracts have been cleared since its launch in May 2012, compared with over US$84trn at the InterContinental Exchange since 2009.
“The offer to divest LCH SA doesn’t really change a lot,” said Compton. “The real issue is the combining of the OTC and listed liquidity pools in interest rate derivatives and that has never been part of the French subsidiary.”
The planned sale may create greater competition opportunities than the headline figures suggest, however, offering a European clearing foothold to a rival exchange operator that may be just enough to appease regulators.
“While a sale of the French clearinghouse wouldn’t change LCH’s dominance in swap markets, what it would do is allow another competitor without a eurozone clearinghouse to have one immediately,” said S&P’s Edwards. “That makes it easier for a competitor to emerge and it could make a lot of sense for potential buyers, particularly if there are concerns around location policies following Brexit.”
Pan-European stock exchange Euronext was seen as a frontrunner for LCH’s French clearing business while CME has also been linked with the sale. Many believe the unit offers value to CME, which already operates clearing businesses in the US and the UK, and could find itself shut out of the European Union if Brexit negotiations shut the door on single market access.
The European Commission declined to comment on timing of announcements relating to the deal. (Reporting by Helen Bartholomew; Editing by Ian Edmondson)