Last December, Deutsche Boerse, which runs the German stock exchange, reopened the battle for control of Europe’s financial markets. Deutsche Boerse launched an offer for its British counterpart, the London Stock Exchange (LSE). At a price of 530 pennies a share, the proposal valued the LSE at €1.95 billion ($2.5 billion).
A week later, it became clear that Euronext, the holding company for the integrated exchanges of Paris, Amsterdam, Brussels and Lisbon, also wants to win control of the British market. Euronext’s goal is to end all doubts about which exchange is the overall leader in Europe, a position now held by the London exchange.
The battle promises to be a long one. On January 27, Clara Fusse, managing director of the LSE, rejected Deutsche Boerse’s offer. However Fusse was prepared to go ahead with discussions. Jean François Theodore, chief executive of Euronext, took advantage of that opportunity to move closer to London. Meanwhile, Werner Seifert, who heads the German exchange, announced that the Boerse would present another offer. In addition, Seifert wrote off the possibility of making a hostile takeover offer for the British exchange.
These rumblings on the battlefield are actually the second wave of consolidation in this sector. The British and German exchanges lit the first fuse in the battle back in 2000, but that engagement never culminated in marriage because of opposition by family members of the British market, especially the brokers who owned one quarter of the London exchange.
The rupture was made official on September 11, 2000, just days before Amsterdam, Paris and Brussels were due to say ‘Yes, I do.’ The deal blew up during the first months of 2001. The next year Euronext bought 51% of LIFFE, the London international futures market, and Euronext widened its embrace to take control of the Lisbon Exchange.
Are the benefits of buying the London exchange significant enough to justify this bitter battle? “When you look at market size and efficiency, they are creating some very clear advantages with a deal that concentrates power in the current European stock market arena,” notes Sergio Torassa, a consultant and former professor of finance at the Pompeu Fabra University.
“Improvements in Operations and Information”
Gonzalo Chávez, finance professor at the Instituto de Empresa, also sees two kinds of advantages – both “operating efficiency and information efficiency.” The first advantage involves creating economies of scale. “With a single business platform, you have integrated operations and information systems, which reduce costs for the exchanges.”
Chávez adds that “customers in these markets, including companies that want to issue their own shares, will need to compete against fewer exchanges, and will benefit from having lower costs. In this sense, they are demanding that the exchanges provide a service that is more cost-competitive.”
At the moment, Euronext has measured the synergies that could be obtained from purchasing the LSE. However, unlike its German rival, Euronext has yet to make a concrete formal offer for the LSE. Euronext has limited itself to announcing that its offer will be in cash. According to officials in Euronext, purchasing LSE would generate synergies valued at €203 million over the first three years.
“If they manage to unify the structures of the big markets, the way they are planning, it will create a very liquid market,” notes Chávez, “and it will generate greater savings. Making the market more global means investors will buy and sell more, and that implies a reduction in operationing costs.”
When an individual investor wants to buy a share, someone called a market maker must offer a position for buying and selling. The difference between the two positions is called the spread; it represents the compensation that the market maker gets in return for assuming the risk of providing liquidity. “Spreads rise or fall as a function of market liquidity,” says Chávez. “The more buying and selling, the lower the risks are for the market makers and the lower the spreads; that means lower transaction costs.”
The Crown Is at Risk
Nevertheless, all these synergies and operational improvements are just a sideshow compared with the true significance of this deal: The winner will be crowned the undisputed leader of Europe’s financial markets. When the details of his business proposal were presented to the LSE, Jean François Theodore embellished his offer by saying it would create “a European leader that is greater than any other possible combination.” The comment served as a sly attack at the offer by Deutsche Boerse.
It is easy to understand the interest in the LSE, a stock exchange with contracts worth about €4.15 billion, a higher figure than all the combined exchanges that comprise Euronext (€1.98 billion), plus Deutsche Boerse (€1.23 billion) and the Spanish exchanges (€963.4 million). The Spanish exchanges are managed by an organization called Bolsas y Mercados Españoles.
Adding LSE would provide clear benefits in terms of size. The deal would wind up reshaping the stock market map of the continent. “Either of the two deals would leave other European stock markets dead in the water. The new exchange [that includes the LSE] would be the center of attraction. It would be so strong, it would threaten the rest of the markets,” notes Torassa.
Chávez agrees. “There would be a chain reaction in the rest of the markets that do not take part in this deal. Madrid and the other locations would have to make decisions about their future, so that they don’t remain isolated and peripheral.” The other stock markets in this minor league would include the Italian exchange, the Nordic exchange – the so-called OMX, which comprises Helsinki, Stockholm, Copenhagen and Vilnius — and the Swiss exchange. Their financial figures are all slightly below those in the Spanish market.
Creating a giant new stock market in Europe would also have implications in the business world, explains Torassa. “From the viewpoint of companies, those who want to be first-rate would have no alternative but to be listed on this market. That’s what happens now in the U.S. where companies are listed on the New York Stock Exchange. If someone buys the LSE, it will create a sort of Wall Street, European style.”
The Regulatory Obstacle
So far, Euronext’s Theodore has declined to discuss the cost [of a takeover], apparently because of the failure of Deutsche Boerse’s proposal. Instead, Theodore has focused on analyzing the difficulties that face such a deal. Theodore is trying to find a way out, while offering solutions that convince shareholders of both Euronext and the LSE.
Theodore has already gotten to work on one of the most complex subjects, requesting clarifications about regulatory barriers from the Financial Services Authority, the super regulatory agency of British markets. The FSA has already revealed concern that the LSE might fall into the hands of a foreign institution, leading to possible operational problems and challenges to good governance.
According to Chávez, “When it come to regulations, there are several question marks that will have to be resolved over time. There are lots of doubts about what will happen when it comes to transparency and good governance. What are the rules that they are going to use? Which laws are going to apply when it comes time to defend the interests of shareholders in a British company if Euronext or the Deutsche Boerse buy the LSE?”
Torassa agrees. “Important changes would be necessary. A deal that leads to concentration on such a large scale would force other institutions to carry out reforms of the same scope to adapt to new conditions. The problem is that European authorities have an approach that is not really up-to-date along these lines.”
The cards have all been placed on the table, in dramatic fashion. Now everyone awaits the definitive attack by Euronext and Frankfurt [Deutsche Boerse]. Who will win the battle of London? “At the moment, only Euronext has come out with numbers that measure the synergies [that would result]. That fact gives Euronext an advantage. Another factor in its favor is that we know the terms of the offer by Deutsche Boerse, which the London exchange has already rejected. Even if we can only speculate” why, says Chávez.
