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LSE/Deutsche Börse merger vote is only the beginning

Anyone who thinks that a merger between LSE and Deutsche Börse is odds-on now they have shareholder approval should hold that thought — there is still a very long way to go, with many twists and turns ahead.

Both London Stock Exchange and Deutsche Börse shareholders have approved the firms’ proposed merger – in what the exchanges have billed as an endorsement of the "compelling strategic rationale" of the plan. But the reality is that this qualification round was a mere formality, and a barely-scraped-by one at that. 

What it does do, however, is usher in the next round of challenging obstacles.

At just 63.65%, the acceptance of Deutsche Börse shareholders is adequate for the deal talks to proceed (after cutting from an initial 75% threshold), but hardly expresses the same enthusiasm as the firm’s management. And this acceptance is for the terms as they are now. There is every reason to think that those terms could look remarkably different by the time the negotiations are through.

This is a merger which will take a long time to complete and whose most obvious end product will be a cocktail of controversies. 

On every front imaginable there will be obstacles, in the shape of political, commercial, regulatory, competition and financial stability arguments – or perhaps, most dangerously, simple wounded pride. All of these could scupper the deal entirely, or cause a reappraisal of shareholder value.

Combining UK and German businesses of such flagship stature was never going to be comfortable for either country, given the scope for national outrage and embarrassment. But it comes just as the UK referendum on EU membership has given vent to calls for greater sovereignty and a rejection of Europe’s perceived control over the nation’s affairs.

A London headquarters for the merged LSE/Deutsche Börse ‘Holdco’ is surely the bare minimum that the UK government will accept, if it is not to be publicly lambasted for having allowed the theft of the family silver.

But it is reasonable to expect similar assertions from the German government about having a Frankfurt headquarters. Allowing a London HQ would be widely viewed as ceding control not only outside the country, but also outside the EU – an institution that Germany has fought tirelessly in recent years to hold together.

The German state of Hesse will be most vocal in this regard, with a determination to keep as much control of business as possible within its own city of Frankfurt. Since the Brexit vote, Hesse has already been calling for the European Banking Authority to move from London to Frankfurt.

Yet more essential is where euro swaps clearing will take place. A UK exit from the EU would almost certainly prompt the European Commission to demand that this happen within the eurozone – a direct threat to the overwhelming domination that LSE’s subsidiary LCH.Clearnet has in that arena through its London-based SwapClear business.

Deutsche Börse management will no doubt assert that such a repatriation, even if successful, would only make the case for the merger more compelling. Indeed, it could then simply roll over the swaps clearing business from LCH to its own clearing business at Eurex.

But if euro swaps clearing is to move from London anyway, then isn’t the stronger rationale to stay out of the fray and take whatever business from LCH you can in the period of uncertainty caused by Brexit? This is surely what other European clearing houses will be counting on.

LCH could reasonably move euro swaps clearing to its Paris entity with the right transference of licenses, but a prolonged merger entanglement between LCH and Eurex – with the prospect of LCH.Clearnet SA in Paris being sold off to pave the way with competition authorities – can only serve to ramp up uncertainty around both businesses and encourage market participants to go elsewhere.

Get beyond that hurdle and the next looms into view: whether LSE-owned LCH.Clearnet and Deutsche Börse-owned Eurex have to remain separate entities because of “too big to fail” concerns. That is a massive bone of contention given the professed desire of regulators since the financial crisis to curb systemic risk.

Competition authorities will also be stepping in boldly to make sure that they are not handing over total domination to one entity. The governments of France, Belgium and Portugal will make sure they are diligent, given the clearing businesses they host. Rival exchange Euronext in the Netherlands would be another likely opponent. 

Getting through all of this, against such a backdrop, has the makings of a survivalist horror movie. For shareholders cleaving to hopes of resultant value and synergy, the question could become such a movie's tagline: "Who will survive, and what will be left of them?"