Last month’s big story was the proposed merger of the London Stock Exchange (LSE) and Deutsche Börse, unveiled after months of rumour and a few days of intense negotiations. As the dust settles, however, elements of uncertainty mean the move is coming in for criticism from both outsiders and insiders.
What is certain, however, is that the LSE is clinging to a face-saving agreement, which is heralded as a 50-50 merger when in fact most observers agree it is effectively a takeover by the smaller Frankfurt-based Börse. Although the LSE boasts twice the number of stocks at twice the value, and trading is still worth more than twice that of Frankfurt, the latter has stolen a march over the past year with the performance of the high-growth Neuer Markt, development of new instruments, such as futures and options, and a new trading settlement.
This is reflected in the fact that the plan is for the top 350 European blue-chip companies to be traded on a platform run and regulated in London, while the new economy stocks are traded on a Frankfurt-based system. Although it has not been spelt out in detail, both platforms are likely to mirror the existing Frankfurt models. But herein lies the rub. Surely a new exchange should be dedicated to trading efficiently and cutting costs. How does this twin structure reflect that? A hint that it does not could be found in the speech given by Werner Seifert, chief executive-designate of iX, the merged exchange, at the Deutsche Börse annual meeting last month.
Although suggesting that pre-tax synergies would be around E150m, he went on to warn that for the first few years after merger restructuring costs would amount to around E100m a year. The question of costs smacks of the political compromise which meant negotiators were burning the midnight oil last month.
A spokesman for the Deutsche Börse told IPE that negotiations with NASDAQ as well as the stock exchanges in Milan and Madrid and the London International Financial Futures and Options Exchange (Liffe) were continuing, but he significantly omitted reference to Euronext, the tripartite merger of the Paris, Brussels and Amsterdam exchanges. There are suggestions that relations with the latter may prove difficult, and Brussels Bourse chief executive Olivier Lefebvre sounded a sceptical note. Commenting on the absence of a back office merger of clearing and settlement operations, he said, “This is a crucial area and weighs on the costs of the transactions. It is at that point that savings should be made, and Euronext have solved that problem.” Claiming that the new merger did not marginalise Euronext, he said, “I wait to see whether what has been announced by London and Frankfurt is actually carried out.”
To a certain extent this scepticism is justified. London and Frankfurt have set themselves an enormous task, and there are many potential pitfalls. First the exchanges have to get their own members to vote in favour of the merger, and there have already been some murmurings of dissent in London from smaller members. Equally in Frankfurt the board have yet to notify members of a voting date, although it is expected to be before the end of July. There is also the question of the division of regulation, the installation of the Frankfurt system in London, and finally the prickly problem of the euro.
City pressure group Cisco, representing smaller quoted companies, claims to have been inundated with complaints from small to mid-size companies. The plan for 350 blue chip stocks to be listed in London leaves some 2,000 listed companies, over four fifths of them in London, apparently in the cold. “Obviously a rump of companies will not be suited by the merger, and will not benefit to the same extent as others, but we do not anticipate any serious delays,” said a source close to the Frankfurt board. Providing a ready market for this equity may still be an issue in London.
John Pierce, chief executive of Cisco, says his members are very concerned. “I think the biggest problem has been that all the publicity has been about the 350 blue chip stocks in London and the new economy stocks in Frankfurt – but what about the rest? It is mentioned nowhere in the documents to date, and looks like another example of the small caps being marginalised.” Pierce says his members have a number of other concerns which he is keen to take up with the LSE. “There are questions of the regulatory authorities, if some of our hi-tech companies look to Frankfurt for quotes do they come under the German regulatory authorities? Many are small and simply do not have the corporate infrastructure to deal with such a change. Do we have to be quoted in euros? Now the LSE seems to be backtracking on that issue in evidence to the House of Commons finance committee.”
Pierce believes that the whole merger has been conducted in haste without a serious plan. He also suspects that Frankfurt may also have a rough ride from some of its members when the merger finally goes to a vote.
On the question of regulation Guy Wisbey, director of markets and exchanges at the Financial Services Authority in London, says, “The FSA has kept in close touch with developments at the London Stock Exchange to ensure that regulatory issues are taken into account. We welcome the Stock Exchange’s commitment to continuing to give a high priority to investor protection and market transparency. These are very important for the international standing of the new entity. Clearly we will need to look at the regulatory implications, but we are confident that we can reach a satisfactory outcome for markets and investors. We will be working through the detail with our German supervisory colleagues, especially the BAWe, with whom we already cooperate closely, to arrive at a sensible regulatory outcome for iX.”
As for the installation of the Frankfurt trading platform, no-one will be sorry to see the end of Sets, the trading system for large companies introduced in 1998. Nevertheless their is no guarantee that the Frankfurt model is any better, nor more likely to deliver more liquidity. Some analysts suspect that the sheer cost could yet scupper the merger.
Perhaps the most controversial issue, which has been the subject of some heated debate over the past few weeks, is the question of pricing in euros. At the announcement of the merger it was made clear that stocks could be priced in pounds, euros or both but that “subject to market conditions and consultation, the aim is for all equity trading to ultimately take place in euros”. While this has serious consequences for retail investors, institutional investors have also expressed concern about the prospect of adding a currency risk, and quite a significant one at the moment.
There is, of course, an underlying logic to trading in the euro, which is after all the currency of convenience, if not of choice. Further, institutions seeking to use the new exchange to simplify the way they trade are not going to be keen on the extra costs of running two accounts. However, the big UK pension funds were quick to raise concerns last month. As they pay out in sterling they too are affected by exchange rates as long as the pound stays out of the mechanism. While the status quo is easy for companies listed in London, companies listed in Frankfurt will surely opt for the euro.
So far news of the merger has been confined to the business pages, but arguments over the euro will catapult it on to the front pages, and make it a popular leader subject. The architects of iX may well find that this could be the issue that will cause them most grief over the coming months.