German D-borse to Acquire New York Stock Exchange? Who Benefits, How Will US Politicians Weigh In and When Does Too Big To Fail Become A Global Problem?

The Deutsch Borse and the NYSE are in advanced merger talks, though this will really be an acquisition of the New York exchange by the Germans. The questions that are raging now are: why? to whose benefit? will US politicians let this happen (an exquisite side-bar question is how conservatives will come down between their avowed obeisance to the free market versus their nativist pride)? and when does the concept of 'too big to fail' begin to apply to markets?

As this page has explained before, access to global capital and the ability of companies - and governments to raise said capital - is crucial to the functioning of an advanced economy. The concern is that this represents a further concentration of financial power in the hands of the banking industry interests who brought the world to the brink during the financial crisis. In the following FT Trading Room analysis, Jeremy Grant explains why this is problematic:



"Herr Niederauer, how is your German?

The prospect that the New York Stock Exchange might fall into the hands of the Germans – that is, Deutsche Börse – is but one of the many fascinating, game-changing aspects of the announcement today that NYSE Euronext and Deutsche Börse are in advanced talks that may lead to a sort of a merger. Except that, in the all-shares transaction, Börse shareholders would end up with up to 60 per cent of the shares in the new group.

This will surely not go unchallenged by US politicians, in particular Democratic Senator Charles Schumer, long known for defending New York’s corner when it comes to financial services.

For those who remember the Börse’s ill-fated attempt in 2002 to take on the Chicago Board of Trade, the US’s then-dominant futures exchange, it is a bit of deja vu. The Germans were rebuffed through a bit of old Chicago style street fighting. Sensitivities were high. And politics played a part in defeating Eurex, the Börse’s futures arm, in its attempt to prise trading away from the CBOT.

This time may be different. The scale of the enterprise is far greater and more complex, and the global exchange business has moved on a long way since 2002.

This is about more than simply control of the Treasury bond futures contract in Chicago. It was – and is – a huge pool of liquidity. But the game now is a mixture of an anti-Chicago ploy, building a big derivatives silo in Europe, to match the pool of liquidity that Chicago has and, for Deutsche Börse, making one last attempt to build a transatlantic business.

Its latest attempt, the purchase of International Securities Exchange, the options exchange, has been a disaster. Look at the write-downs on that deal, where Deutsche Börse paid $2.8bn.

For Mr Niederauer, this fulfils a number of objectives. And let’s dismiss the cash equities piece of this, right off the bat. This is about derivatives and clearing, which is what drives exchange M&A these days (it is also why Mr Niederauer’s predecessor, John Thain, bought Euronext in the first place – to get hold of Liffe, the high-margin futures exchange then-owned by Euronext).

Structurally, this is about consolidating an integrated derivatives and clearing business in Europe, not just as a way of heading off CME encroachments in the region (note that CME last month got approval from UK regulators for a London clearing house) but also as there is an almighty battle over the role of “vertical silos” brewing thanks to regulatory reforms such as Dodd-Frank in the US and “Emir” and “Mifid” in Europe.

NYSE Euronext and Deutsche Börse are feeling the pressure from competition on the cash equities side from the fragmentation of markets across multiple different types of venues - BATS and Direct Edge, broker networks, “dark pools” in the US, Chi-X and other similar interlopers in Europe. The answer is to reinforce the power of the derivatives-clearing silo. That’s where the obvious returns are.

Does this cause an antitrust issue in the European Union, given how much power vertically integrated exchanges with clearing houses have?

I think the scaremongers on this are (probably) wrong. Again, go back five years. The US Department of Justice waved through the Chicago Board of Trade’s takeover by the Chicago Mercantile Exchange. What were the exchange’s two main financial products? Eurodollar interest rate futures – at the short end of the yield curve – and at the CBOT, Treasury bond futures at the long end.

Slam NYSE LIffe and Eurex together in Europe – as the NYSE Euronext/Deutsche Börse deal envisages – and you have exactly the same scenario playing out in the European equivalent of those products. Do we seriously think that antitrust people in Brussels are going to have a problem with this, when the Department of Justice in the US approved it for Chicago? Okay, the staff in that same department expressed serious reservations later in an infamous letter to the US Treasury, but the original decision still stands.

And imagine this: let’s say you are the CME and you are lobbying Brussels against any NYSE Euronext-Deutsche Borse tie-up. You can hardly use the antitrust card, given that you yourself were given a clean slate by your own antitrust people on the same issue a few years ago in the US.

I know that some people might say that the CME argued that the CME-CBOT deal was okay from a competitive standpoint because there was a third party, IntercontinentalExchange (ICE), to keep everyone honest. But ICE never offered the same products as either Chicago exchange.

The real losers here, potentially, are the market participants who hoped that we might have arrived at a point where vertical silos were being challenged by what is coming out of Dodd-Frank and Emir in Europe when it comes to things like open and non-discriminatory access to clearing houses by trading venues. The tendency seemed to be away from big vertical silos, driven by for-profit exchanges. If you are LCH.Clearnet, for example, this has not been a good 36 hours, given your user-owned, quasi-utility structure.

The slow death of “interoperability” between clearing houses in Europe in recent weeks is also a blow against those who had hoped for a democratisation of market structures away from the vertical silo.

Mr Niederauer and his counterpart at Deutsche Borse, Reto Francioni, had better know what they are doing. All I see in the announcements over the last two days from incumbent exchanges is hyperbole about creating global “powerhouses”. The question is, for whose benefit?