It is Valentine’s Day this month and Deutsche Boerse is making eyes at the London Stock Exchange once again. If the German exchange successfully woos its long time British love or even takes it by force through a hostile takeover, the implications for the clearing and settlement of trades in Europe will be far-reaching. There will be different but equally important consequences if LSE should fall for the charms of its rival suitor, French exchange Euronext.
The Deutsche Boerse-LSE courtship first began in May 2000 when the two exchanges drew up plans for a pan-European bourse called iX. These marriage plans were scuppered, however, when Swedish technology firm OM Gruppen cut in, offering to buy the London Stock Exchange. Neither of the deals went ahead and by September the LSE was chasing an obsession of its own, the London Financial Futures and Options Exchange. It was eventually the French bourse Euronext who bought LIFFE, leaving the LSE conspicuously unattached.
So few eyebrows were raised when December 2004 saw forthright Deutsche Boerse boss Werner Seifert making overtures to the LSE’s demure chief executive Clara Furse. Although the original proposition was rejected, in January the German bourse stepped up the pressure, making public the details of its proposal, including an offer to pay 530p per share. This is seemingly in the hope of persuading both LSE shareholders and users to back the deal and thus exert their influence on Ms Furse.
At the time of going to press the LSE remained unmoved. Meanwhile, Euronext too has been romancing the LSE and appears to be ready to trump any offer from Deutsche Boerse.
Mr Seifert says that if he gets his way the deal would “realise manifold growth opportunities in Europe and globally”. He claims that the merged entity would “become the first global exchange organisation”, a model of the harmonisation that the financial industry has been crying out for.
Price reductions
Customers of the stock exchange would enjoy a range of immediate cost cuts, he says. The cost of current tariff structures for electronic order book systems in the UK would be reduced by 10 per cent from January 1, 2006. Mr Seifert would then cap prices at that level for “at least five years” and would hope to decrease them further thereafter.
The Boerse would also attempt to bring down clearing costs. It would make a long-term arrangement with the LSE’s settlement company Crest Co (owned by Euroclear) but it would also extend the LSE’s contract with LCH Clearnet – although only by one year. In return for this Mr Seifert says he would “expect the LCH to contribute to the improvements” by cutting their fees by 50 per cent.
He hits back at criticisms of Deutsche Boerse’s business structure as monopolistic, griping that the often-used description of it as a “vertical silo” is “meaningless”. “We think that in exchange for extending LCH’s contract they can bring down their fees. It would not be for our benefit but for the benefit of users. That is, by the way, what competition brings to a market,” he says.
But he is evasive on what might happen after LCH’s one-year contract expired. Similarly, although Mr Seifert says, “we are happy with the services of LCH and Crest” and “Crest is such an implicit element of the London post-trade chain that we would be crazy to change it” a question mark surely hangs over where Deutsche Boerse’s own clearing unit, Clearstream, would eventually fit in.
Ruffled feathers
Clearstream’s rival Euroclear, the European share settlement system owned by its members, is far from comfortable with the deal on the table. It has said that Deutsche Boerse should sell both its clearing and settlement businesses – Clearstream and Eurex – as part of any move to takeover the LSE. Euroclear fears that it could lose out dramatically if Deutsche Boerse takes over the LSE and remains owner of Clearstream.
Denis Peters, director at Euroclear, says warily that he would be happy “as long as post-trade operations remain competitive, so we can compete on a level playing field”.
Deutsche Boerse has responded to Euroclear’s position by accusing the pan-European settlement provider of having conflicts of interest of its own. Mr Seifert cites a report from Fair & Clear, a banking group led by Citigroup and BNP Paribas, which says Euroclear’s banking and settlement businesses should be separated. They argue that the company’s acquisitions of local CSDs allow its banking operation to offer cut-rate prices, giving it an unfair advantage over other banks.
But Euroclear is not the only critic of Deutsche Boerse’s proposed deal. Don Cruikshank, who chaired the LSE from 2000 to 2003 and led the original merger talks between the LSE and Deutsche Boerse, has also said that if Deutsche Boerse merges with the LSE it should be required to dismantle its clearing and settlement “vertical silo”.
So how would a Euronext-LSE tie-up compare? Euronext, clears trades with an independent group. For this reason its business model is said to be preferred by the European Securities Forum, which represents 20 users of the LSE, including Morgan Stanley, UBS and Goldman Sachs. They prefer that share deals are settled by an organisation which operates independently from the exchange itself.
But Mr Cruikshank is among those who would have a problem with LSE merging with Euronext, in its current form. He says that if the Paris-based exchange wins a rival bid for the LSE, it should be required to complete its withdrawal from the vertical silo of clearing and settlement.
He believes that whether the German suitor or French admirer wins the heart of the LSE, in neither case would promises of good behaviour on their own suffice.
SHAREHOLDER ISSUES
Deutsche Boerse’s noises about buying the London Stock Exchange are making its shareholders twitchy. The outcome of events, and in particular the extent to which the German exchange listens to its owners, will be an important test case for international corporate governance.
Standard Life is one of the largest companies which owns shares that is prepared to go on record regarding the issue. Richard Moffat, investment director, pan-European equities, Standard Life Investments, says Deutsche Boerse’s announcement of the price it would offer for LSE shares – 530p – is a “positive step”.
“We are happy that they are now providing more information on the rationale behind the proposed deal. We will be meeting the company soon and look forward to discussing the merits of the deal in more detail. But the onus is still on Deutsche Boerse’s management to demonstrate why the purchase of the LSE creates more value for shareholders than other strategies, such as a buyback."
Another shareholder, who preferred to be anonymous, said “many of us believe Deutsche Boerse should use the cash they are proposing to spend on something more than buying the LSE. If you over extend yourself it affects the value of your share price. If the German bourse resists the will of its shareholders, that will tell you a lot about its culture and what it might do to the LSE. If you look at Clearstream, none of the senior management from before the [Deutsche Bourse] takeover are still there except Andre Roelants.”
Meanwhile, a gaggle of hedge funds have revealed themselves to be shareholders in the German bourse. Children's Investment Fund Management, a UK hedge fund known as TCI, is claiming to own more than 5 per cent of Deutsche Boerse. It has written to the German exchange demanding that it seeks shareholder approval before making a move on the LSE. TCI’s request for an extraordinary general meeting was met with a frosty acknowledgment from the Deutsche Boerse.
It said in a public statement: “TCI alleges that the price of 530p per share proposed by Deutsche Boerse for the acquisition of the London Stock Exchange exceeds the potential benefits of this acquisition… Deutsche Boerse is convinced that its contemplated cash acquisition of the LSE is in the best interests of its shareholders and the company.”
Hedge fund manager Atticus Capital and a US-based fund manager, Harris Associates, are among those arguing that a share buyback would better serve the exchange's shareholders.
According to our anonymous shareholder: “Whether Deutsche Boerse takes over the LSE will all depend on how determined to leave a legacy Mr Seifert becomes. He doesn’t have much of a long strip of patience, so he may do something on a hostile basis”.
