London and Frankfurt, a Marriage of Interest

THE MERGER BETWEEN DEUTSCHE BOERSE AND THE LONDON STOCK EXCHANGE COULD BE A LASTING PARTNERSHIP AND BENEFICIAL TO BOTH TRADING MARKETPLACES: THE FORMER WOULD GAIN A DERIVATIVES MARKET AND BOTH WOULD BE STRENGTHENED AS CLEARING HOUSES, WHILE HAVING A STRONGER IMPACT AS A UNIFIED MEDIA COMPANY

by Manuela Geranio
Translated by Alex Foti

The agreement to achieve a merger of equals recently announced by the London Stock Exchange Group (which includes Borsa Milano) and Deutsche Börse reopens the chapter of mergers between bourses, after a two-year period of truce. That truce had been established as a result of the divorce by mutual consent between ICE-NYSE and Euronext in 2014, which had established de facto the failure of the largest intercontinental aggregation ever attempted between markets. Why then should the newly announced operation have a different outcome?
The financial crisis has severely depressed not only prices but also the volumes traded on stock markets, both in Europe and the United States. To date, volumes traded on regulated markets are very far from their pre-crisis levels, in part due to the structural transformation that occurred in the exchange industry. Competition from alternative trading systems, already operating for some time in the US market and favored in Europe by MiFID regulations, has effectively removed a growing share of trading from regulated markets, transforming the activity that traditionally represented the core business of stock exchanges into little more than a commodity. Hence the need for regulated markets to expand their size, while at the same time diversifying their product portfolio in order to more easily recoup defensible margins.
 
The reasons it could work
The increase in size allows greater economies of scale to be realized on the increasingly significant technology investments required by bourses to offer their services to highly sophisticated and demanding customers (think of the infrastructure necessary to ensure the operations of high-frequency traders). In a mature market, acquisitions represent the fastest (and often the only) opportunity for growth. As for the diversification of products, trading derivatives, post-trading activities and selling information have become increasingly important revenue sources in all major exchanges.
The trading of derivatives ensures higher margins as the products traded are the property of the bourse and therefore harder to be imitated by external competitors. Also in the case of post-trading (including all services subsequent to trading or clearing, settlement and depository) stock exchanges maintain a basically non-contestable position (except from other exchanges). Recent obligations requiring on-exchange clearing for over-the-counter derivatives favor a natural increase in demand for such services, to the benefit of marketplaces capable of operating on multiple markets with diversified instruments.
 
Even in the case of selling data, bourses have a defensible market position, financial information being the joint product of trading activities. Bourses have enhanced their role as content providers by acquiring control of some of the leading index manufacturers (think FTSE owned by LSEG, and the EURO STOXX index property of Deutsche Börse).
The planned LSEG-Deutsche Börse merger might therefore work because London lacks a significant derivatives market such as Eurex, and both exchanges could consolidate their role in clearing (where one is currently the closest competitor of the other), while easily increasing their weight as a single media company. A marriage of convenience that would strengthen the position of both in a highly competitive global industry which is bound to become more concentrated in the hands of a few, large and diversified players.