With the prospective merger between Deutsche Börse and NYSE Euronext teetering on the brink of collapse, the two exchanges may have to rethink their strategies and take a slower approach towards consolidation.
Indeed all bourses may have to rethink their approach given the number of failed merger attempts last year.
The DB/NYSE deal was initially announced around a year ago but is now close to being terminated following press reports claiming that Joaquin Almunia, the European commissioner leading the antitrust probe, has recommended blocking the deal in a draft report that is currently circulating in Brussels.
While ominous, the rejection is far from formalised with a further round of intense lobbying expected prior to the European Commission’s official 9 February decision deadline.
The main criticism of the deal is its potential to create a monopoly in European exchange-traded derivatives. The reports suggest that the divesture of Eurex or Liffe, the derivatives exchanges owned by Deutsche Börse and NYSE Euronext respectively, would be the only way the European Commission would give its blessing to the deal.
However, the chances of the exchanges selling off their derivatives units are slim, as their combination has often been cited as the main rationale for the deal by the exchanges’ executives. The bourses have already made a series of concessions designed to allay monopolistic fears.
With 2011 being remembered by many as the year of numerous failed exchange mergers, where can the exchanges go from here?
Partnerships between exchanges are growing in number – particularly between those in developed and emerging markets – and are a less regulatory intensive means of growing revenues. Eurex already has a partnership with the Korea Exchange, reporting strong volumes in the KOSPI futures contract last year. NYSE Euronext launched a cross-market access solution with the Tokyo Stock Exchange last December. Increasing these types of arrangements opens up new markets for bourses to explore.
“I don't think there is a need for either Deutsche Börse or NYSE Euronext to hurry and look for new merger opportunities and I think exchange consolidation will happen in smaller increments in the future,” Niki Beattie, managing director at consutancy market Structure Partners, told theTRADEnews.com. “We may see more strategic partnerships in the short-term that allow markets to develop trust and to demonstrate capabilities in certain areas before committing to consolidation.”
A couple of examples from recent years include the CME Group’s link with Brazil’s BM&F Bovespa, which initially started as a cross-listing arrangement and later resulted in each taking a 5% stake in the other’s company. The partnership also resulted in a new US$200 million trading platform at BM&F Bovespa, based on existing CME Group technology. Furthermore, the Mercado Integrado Latino Americano, an alliance that links markets in Chile, Colombia and Peru, was established last year and could grow further if Mexican joins this year.
It could be argued that this approach for greater geographical diversity would benefit Deutsche Börse the most, given that its business already covers European equity and derivatives trading and clearing via Xetra and Eurex, settlement and custody via its Clearstream subsidiary, and market data and indices via its STOXX business.
Banking on regulation?
The next few years will also see a raft of new legislative measures that could either stimulate or hinder exchange revenue growth.
The European markets infrastructure regulation (EMIR) and the US’s Dodd-Frank Act include proposals to standardise OTC derivatives so that they can be traded on exchange and centrally cleared. With the detail of the new rules due to be finalised in the coming months, exchanges have been looking for ways to tap into a market that was worth US$708 trillion in the first half of 2011.
Capital constraints imposed by Basel III also offers opportunities for exchanges to fill the gap left by banks that may have to exit certain capital-intensive activities.
“The ability of banks to stump up risk capital will be reduced under new regulations, which offers exchanges the opportunity to try and facilitate these types of models without disintermediating their customers,” said Hirander Misra, former COO of multilateral trading facility Chi-X Europe and founder of consultancy Misra Ventures. “This is likely to be focused on hybrid quote-driven trading models with reporting and clearing functions, as opposed to order book models.”
Misra is currently working with UK market operator PLUS Markets Group on the development of PLUS-TS, the firm’s new trading technology unit.
EMIR along with MiFIR, a new regulation that will accompany MiFID II, could compel exchanges to open up both equities and listed derivatives clearing facilities to competitors. This would attract revenues to the largest clearing houses, such as Eurex Clearing, as market participants seek to reduce costs through margin offset arrangements, although this is not guranteed. Access to Eurex Clearing was part of the remedies offered to regulators as part of efforts to get the deal passed.
However, what regulation gives with one hand could be taken away with the other, if open access provisions to benchmark indices are upheld.
This could force Deutsche Börse to allow competitors to base products based on the hugely popular EURO STOXX 50 index, which would ultimately reduce its income
Furthermore, Misra points out that a year of – what appears to be futile – lobbying would have incurred opportunity costs. While DB/NYSE have spent a tremendous amount of time trying to convince stakeholders of the industry logic of their combination, other exchange groups and financial institutions have been busy planning for the opportunities related to new regulation.
One of the main motivations for the DB/NYSE deal was its potential to offset the domestic bourses falling equity market share following the elimination of the concentration rule through MiFID in 2007. With the two largest multilateral trading facilities, BATS Europe and Chi-X Europe, recently completing a merger that gives them a combined market share of over 25% – the largest in Europe – local stock exchanges could fall further behind. BATS Chi-X Europe have also moved ahead of domestic exchanges in equity clearing, offering members the ability to cut post-trade costs with four-way interoperability.
The London Stock Exchange (LSE) has also made up ground after making a slow start post-MiFID. Within the last two years, the LSE has bought Sri Lanka-based trading technology firm MillenniumIT, launched equity derivatives trading on its own Turquoise MTF and is currently locked in discussion with clearer LCH.Clearnet, which would give it a further opportunity to diversify its revenues.