The breakdown of the merger between Deutsche Börse and NYSE Euronext could reinvigorate lobbying efforts to protect the vertically-integrated exchange model, market observers have warned.
Two pieces of legislation, MiFID II and the European market infrastructure regulation (EMIR), include open access and interoperability requirements that would force competition on exchange groups such as Deutsche Börse that run both trading and clearing businesses. Deutsche Börse offers trading in German and international stocks on its Xetra electronic trading platform, owns derivatives exchange Eurex and clears equities and derivatives trades through Eurex Clearing.
“The DB/NYSE merger appeared to be a defensive move to protect both exchanges’ derivatives businesses from impending competition in the listed and OTC derivatives space,” suggested Diego Valiante, research fellow at the Centre for European Policy Studies. “I would now expect the exchanges to apply pressure via the regulatory process and in particular to the principles of open access and interoperability in MiFIR.”
Deutsche Börse and NYSE Euronext received formal notification on 1 February from the European Commission’s competition authority that their proposed merger would not be permitted because of the monopoly it would create in listed derivatives. Access to the Eurex trading system for firms looking to launch interest rate derivatives and access to Eurex Clearing were among the remedies offered to the Commission by the two exchanges as part of efforts to push their deal through.
MiFIR, a regulation that will accompany MiFID II and leave member states with no room for interpretation of how they transpose the new rules, includes an obligation for central counterparties (CCPs) to “accept clearing of and clear financial instruments on a non-discriminatory and transparent basis”. The rules would apply to equities and listed derivatives.
While Eurex is arguably Europe’s strongest listed derivatives market, the collapse of Deutsche Börse’s merger with NYSE Euronext – combined with MiFIR’s open access requirements – will likely reduce its revenue opportunities.
“MiFIR is yet another clear message from European regulators that monopolies in trading and clearing are unacceptable,” said Niki Beattie, managing director of consultancy Market Structure Partners. “It is not a good long-term trend for the profitability of Deutsche Börse but most would hope it spurs them to be innovative and look to create new products.”
In equities, Deutsche Börse is one of a group of domestic exchanges that have sat on the sidelines while other trading venues – including BATS Chi-X Europe, Turquoise, Nasdaq OMX Nordic, UBS MTF and Nordic MTF Burgundy – have pursued interoperability initiatives ahead of MiFIR’s introduction. A number of large brokers have already consolidated their clearing flows with one CCP and those venues that offer a choice of clearers are expected to increase their market share.
Since the introduction of MiFID in 2007, Deutsche Börse has seen its share of German blue chips fall steadily. At the start of 2009, its share of DAX stocks was 76.9%, falling to 68% at the start of 2011 and 63.7% last month, according to data from Thomson Reuters.
Influencing EMIR
EMIR, which sets a new regulatory framework for OTC derivatives, includes the same principles of clearing interoperability as MiFIR as part of its goal to standardise swaps so they can be traded on exchange and centrally cleared. It will also compel operators of industry-standard benchmarks to make these available to competitors on “proportionate fair, reasonable and non-discriminatory terms”.
After a series of delays relating to the way CCPs should be supervised, the European Parliament, European Commission and Council of the European Union are now scheduled to meet on 9 February to finalise the high-level text. During the debate held by the European Parliament on EMIR last summer, German MEPs disagreed with UK MEPs over plans to extend the regulation to listed derivatives.
After EMIR is agreed, the European Securities and Markets Authority (ESMA) will have until 30 June to write the accompanying technical standards.
Valiante suggested that ESMA could also come under pressure from Deutsche Börse, particularly when it comes to decide which types of OTC derivatives should fall under the new rules and the requirements for licencing benchmarks to rivals.
Deutsche Börse owns index provider STOXX, which owns the hugely popular EURO STOXX 50 and associated benchmarks. London Stock Exchange-owned multilateral trading facility Turquoise lodged a complaint with European competition authorities last year after Deutsche Börse refused the trading venue use of the STOXX indices for its new derivatives platform.
Instead of focusing their efforts on regulation, Valiante suggested Deutsche Börse should look for ways to capitalise on the new regulatory environment.
“After the EMIR and MiFIR come into force, Deutsche Börse will still have an immediate competitive advantage compared to their rivals because of the capabilities they already have, such as a sophisticated trading infrastructure and high economies of scale that will allow them to manage collateral in a very efficient way,” he said. “If they push less on the regulatory side and concentrate more on improving efficiency, they could offset the losses they will incur through regulation.”
Eurex Clearing has already begun shaping its offering for the new landscape, most notably through physical segregation of client collateral in individual accounts, separate from CCP member firms.
MiFID lessons
But Richard Perrott, exchange analyst at private German bank Berenberg, pointed out that the success of equity MTFs since MiFID’s initial introduction in 2007, could be repeated in other asset classes.
“It would be a mistake to think that there'd be a reliance on incumbent exchanges for the trading of listed derivatives in light of the fierce competition we have seen in cash equities post-MiFID I. If anything, the extremely high liquidity in certain futures contracts would arguably make them easier to fragment.” he said. “Banks and other market participants would seek to increase pricing pressure on incumbents by supporting new trading platforms, and would also hope to benefit from becoming liquidity aggregators in a fragmented market.”
MiFID II will extend the types of asset classes covered by the original directive to include listed derivatives, fixed income and commodities.
One way to deal with greater competition, according to Beattie, would be cross-continent collaboration.
“Exchanges need to seriously consider who they want to be working with in the long-term, particularly as interest in Asian markets and cross-border trading escalates,” she said. “As well as EMIR, new regulation will constrain banks’ ability to offer funding for OTC products and the need to minimise risk is also pushing more buy-side firms into listed products, offering more revenue opportunities for exchanges.”
The most significant capital constraints on banks will come via Basel III, which will seek to impose a minimum tier one capital ratio of 6% on banks by 2015.