24 January 2005
Battle of bourses to reshape capital market
The fight for the London Stock Exchange will send shock waves through the
fragmented securities markets of Europe, says Stewart Fleming
SINCE the launch of the euro, the minds of the most polished financial market
policymakers in the EU have been grappling with a perplexing problem. How do
we sweep aside Europe’s protectionist traditions in order to exploit to the full
the euro’s potential? How should Europe restructure national capital markets
and the cross-border clearing and settlement systems through which billions of
euros flow each day, to turn them into the wealth-creating colossus we see in
New York?
On 13 December 2004, Deutsche Börse (DB), Germany’s leading stock exchange,
changed the terms of this debate. It announced that it wanted to launch a £1.35
billion(€1.91bln) takeover bid for the venerable but vulnerable London Stock Exchange
(LSE), Europe’s dominant stock market.
If the bid succeeds, the future structure of Europe’s securities markets will have been
determined at a stroke. The privately owned DB, with its vertically integrated “silo” of
financial market operations covering everything from trading shares, bonds and
derivatives through clearing and settling billions of euros of securities deals, would
dominate public trading in the EU’s securities markets.
Seeing that its worst fears could be realised, Euronext, DB’s Paris-based rival which
combines the Paris, Amsterdam and Lisbon stock markets, and London’s Liffe financial
derivatives market, launched its own merger talks with the LSE.
But instead of welcoming the DB initiative and the possibility of a quick solution to the
challenge of rationalising Europe’s inefficient and expensive structures for trading
securities across borders, the prospect of a successful Frankfurt putsch is being greeted
with dread – and not just by its rivals.
“If, as many expect, the Madrid and Milan stock exchanges decided to link up with a
dominant Deutsche Börse following its takeover of the LSE, investors would end up facing
a privately owned monopoly supplier of pan-European securities dealing services,” says a
member of the Giovannini Group of securities market experts which advises the
Commission.
Were Euronext to buy the LSE it too could expect, in time, to come to dominate
securities trading in Europe. But Euronext does not own clearing and settlement
operations, so the breadth of its grip on the markets would be weaker and some of the
prudential and competition issues raised by the DB bid would be less worrying.
It is not just the potential market power of a DB/LSE merger which is causing concern.
Last week, Sir Nigel Wicks, deputy chairman of Euroclear, DB’s Brussels-based
competitor, questioned the quality of the regulation of an institution which would operate
a clearing and settlement system critical to the stability of Europe’s financial markets –
the DB’s regulator is the German state of Hesse. He highlighted concerns that it is DB
shareholders, not its users, who would call the shots on crucial decisions, including
pricing moves and clearing and settlement issues.
Some experts claim that cross-border securities transactions in the EU are up to ten
times as expensive as those levied in the US. The LSE estimated that end-users bore up
to €1.6 billion of excessive costs annually. DB put the figure at €3.2bn. The
fragmentation of EU securities markets makes markets less liquid, raises the costs of
capital, makes its allocation less efficient and makes the single currency less attractive to
investors. These factors risk weakening long-term growth. But there are political costs
too. The EU will be less able to influence issues relating to global corporate governance,
investor protection and reform of international accounting standards, if its currency is not
underpinned by vibrant and well-regulated securities markets.
Last April, the Commission stressed that modernising a cross-border EU clearing and
settlement system was one of its priorities. It listed 15 barriers to EU-wide integrated
systems, ranging from the diversity of information technology platforms to national
differences in tax and legal systems and market rules. The Commission policy paper
favoured the “combined intervention of market forces and public authorities” to create
“an efficient, integrated and safe” pan-European clearing and settlement system
“operating in full conformity with the EU’s competition rules”.
The question that the Commission, governments and investors are now asking
themselves is: would a Deutsche Börse bid for the LSE meet these criteria and, if not,
what can be done about it, and by whom?
Back in December, most observers thought that such was DB’s financial firepower it
would prove the likely winner of any contest with Euronext. But now they are not so
sure. Some big DB shareholders are objecting to the high price that might have to be
paid. There are growing concerns that regulators, perhaps London’s Financial Services
Authority, will demand changes in the structure of the bid in return for approval –
changes which will make the deal even less attractive to DB’s worried investors.
 Stewart Fleming is a Brussels-based freelance journalist