No one does hostile takeovers quite like the
Americans, and Nasdaq OMX and Intercontinental Exchange look
like masters of the art.
As FOW went to press, their bid offered NYSE
Euronext shareholders a premium of around 15% over the offer
from Deutsche Börse, after share price movements that
eroded some of the hostile bidders’ advantage.
The pair have also taken the gloves off and thrown
them away. The offer document touched nerves in Frankfurt when
it questioned Deutsche Börse’s track record
with mergers, saying that its 2007 acquisition of the
International Securities Exchange had not lived up to
While many in the industry had predicted that a
rival bid might emerge, the size of the offer caught many by
surprise. Nasdaq and ICE are now doing the rounds of NYSE
Euronext shareholders, hoping to force the board to meet them
As the Deutsche Börse bid is structured as an
all-share merger, the NYSE board is not obliged to seek the
highest price for the company. However, pressure from
shareholders at the company’s AGM – due
to take place on April 28 as FOW went to press – may
force the company into talks.
Strengths of the bid
At $42.67 a share based on April 18 closing prices,
the revised Nasdaq/ICE bid submitted on April 19 was then a
21%, or $2bn, premium over Deutsche Börse’s
offer. The exchanges also claim they will be able to find far
greater efficiencies than NYSE-Börse, originally promising
an additional $300m of savings, achievable in a shorter
Their plan is to split up NYSE Euronext, with
Nasdaq taking the New York Stock Exchange, the Euronext
stockmarkets of Paris, Amsterdam, Brussels and Lisbon, and the
NYSE Arca and NYSE Amex options exchanges in the US.
ICE would take over Liffe’s thriving
futures and options business, including NYSE Liffe US and its
joint venture clearing house, New York Portfolio Clearing. This
would diversify ICE’s business greatly and move
its centre of gravity still further into Europe (see
A combined ICE-Liffe business would propel ICE up
the derivatives league table, tripling its current volumes by
adding over a billion traded contracts a year to its
The businesses are very complementary –
Liffe would strengthen ICE’s commodities offering
a little, but would add much more weight to its equity index
product portfolio. The combined group would have $1.8bn of
revenues, just over half of CME Group’s, and trade
1.5bn contracts a year.
US regulators might raise objections to the
combination of NYSE and Nasdaq and their dominance of the US
cash equities and equity options markets, in each of which the
combined entity would have about a 50% share of trading.
In Europe, joining Nasdaq’s Nordic
stockmarkets to those of Euronext would knock out one big
equity market player and regulators might want to consider
that. But as in the US, traditional exchanges now face fierce
competition from start-up electronic venues such as Bats and
However, the ICE-Liffe tie-up is unlikely to raise
any competition concerns on either side of the Atlantic. NYSE
Liffe US is still tiny and anyway the US futures market is
highly consolidated in the hands of CME Group. In Europe,
ICE-Liffe would still be smaller than Eurex by number of
The Deutsche Börse bid also raises competition
problems, arguably more serious ones – and especially
in Europe, where the European Commission perhaps has a more
hawkish track record on such issues than the US Department of
NYSE-Börse would own a pan-European
derivatives powerhouse with over 3bn contracts traded a year
– a fraction more than CME in 2010. Although its share
of the European futures market, not counting Russia, would be
less than CME has in the US, when you throw in options, it
would have a bigger slice of the whole listed derivatives
market – 91%.
It would also unite the Frankfurt stock exchange
with all the Euronext markets, creating a much bigger
competitor for the London Stock Exchange, Nasdaq OMX and
national markets like Bolsas y Mercados Españoles and
In the US, the deal would create a concentration in
equity options, where Eurex’s International
Securities Exchange is the third biggest market. But even with
Arca and Amex this would have a smaller market share than the
To sum up, there are concerns about competition
with both bids. One creates a monopoly in US securities which
would also be a dominant player in options and, separately, a
diverse, transatlantic derivatives business. The other would
lead to a monopoly in European listed derivatives, which was
also a big hitter among European stockmarkets and a diverse,
transatlantic securities business.
Nasdaq and ICE have tried to pre-empt the concerns
about competition, both by highlighting the fact that they
think the other bid is more at risk, and by offering a $350m
reverse termination fee, payable if the deal falls at the
regulatory hurdle. This is intended to demonstrate their
confidence in getting the deal past the watchdogs, and to
undermine the NYSE board’s argument that
"unacceptable execution risk" is a reason to reject their
However, market participants say the terms of the
termination fee are onerous and it is unlikely that the
conditions of payment will be met.
Deutsche Börse is likely to argue that its
combined derivatives behemoth would act as a counterweight to
the US’s CME Group, and that any competition
ruling should be made in a global rather than a European
The German exchange has a point: with its Globex
electronic trading network reaching all over the world, CME is
in many ways a global exchange now.
However, NYSE-Börse’s dominance
in Europe would be such that regulators could only approve it
if they really believed derivatives exchanges were a special
sector where norms of competition policy did not apply.
However, competition is growing in derivatives from
lower cost, smaller exchanges. On April 12 Turquoise, the
multilateral trading facility owned by the London Stock
Exchange and a group of banks, did Deutsche Börse a big
favour by announcing that it would begin offering FTSE 100
derivatives from June.
Competition is also expected to come from the
combined Bats Chi-X Europe, which is being formed through the
acquisition of Chi-X Europe by Bats Global Markets.
The group hopes to replicate its success in the
cash equities market, where the two MTFs together account for
around a quarter of European stock trades. In March Chi-X
signed a deal to create derivative products based on regional
indices with Russell Investments as part of its push into the
In any event, many derivatives market participants
are in favour of the global trend for exchange consolidation.
One professional from a leading bank, who did not want to be
named due to his firm’s involvement in the deal,
said: "There is a huge benefit to the market in creating a
single trading and clearing entity providing a central pool of
"There are lots of people launching derivatives
trading or clearing services, but ultimately liquidity is key
War of the models
What is causing concern among market participants
and regulators alike, however, is the expansion of the vertical
silo model in clearing that either deal would create.
In the vertical clearing model, an exchange owns
the clearing house that clears its trades. One consequence of
the wrangle for control of NYSE Euronext is that this issue has
come to the fore, not only in the market but also, and more
worryingly for the exchanges, among regulators.
The pros and cons of the vertical silo model have
been debated since the formation of Clearstream in 2000, when
Deutsche Börse took over Cedel.
Critics of the model, which tend to include smaller
exchanges, rival clearing houses and some market participants,
argue that separately owned clearing houses – the
so-called horizontal model – offer a better chance for
market participants to select the most cost-effective and
efficient service at every stage of trading.
The issues involved are complex. Certainly, if
clearing houses are separate from exchanges, there would seem
to be more chance of the clearing houses feeling competitive
pressure, because an exchange could dump an unsatisfactory
clearing provider and go elsewhere.
However, under current arrangements,
exchanges’ users would still not have any day to
day choice about where their trades were cleared.
The existence of independent clearing houses, such
as LCH.Clearnet, also makes it easier for new exchanges to pop
up, buying in the clearing services they need. That
theoretically keeps some tension on the big exchanges.
But again, the standard service offered by third
party clearing houses stops short of the pooling of risk
between exchanges that occurs in the US options market, where
nine exchanges use the Options Clearing Corp and the open
interest is fungible.
It is this kind of model that attracts some
start-up exchanges, such as ELX Futures in the US interest rate
market, which has tried to lobby the Commodity Futures Trading
Commission to make CME accept trades effectively transferred
from ELX, enabling ELX to benefit from CME’s
liquidity. So far, CME has refused.
The ultimate model, which in the exchange-traded
derivatives world exists only on paper, is called
interoperability, meaning that a single exchange could connect
to more than one clearing house (which could also serve
multiple exchanges). This opens the door to investors having a
much more finely focused choice over where their trades are
An alternative view is that there is no need for
this, or for competition between clearing houses. They are
natural monopolies – but as such, should not be
profit-making entities, operating instead as utilities for the
benefit of the market. The US has gone a long way towards this
model, with the OCC for the options market and the Depository
Trust & Clearing Corp for equities and bonds. The OCC, for
example, though owned by some of the exchanges, rebates profits
to all members once it has spent what it needs to.
Today, however, the futures market is very far from
such utopias. CME, Eurex, ICE and Nasdaq OMX own their own
clearing houses; Liffe is in the process of building its own
and abandoning LCH.Clearnet; LSE Group has thought about doing
Either an ICE-Liffe deal or a NYSE-Börse one
would merge two of these silos into one bigger one.
Anthony Belchambers, chief executive of the Futures
and Options Association, says that, while there are "clearly
potential cost savings to be made through the convergence of
execution platforms and even in the integrated delivery of
execution and clearing services, market competitiveness,
including clearing access, must be taken into account".
He adds: "Getting the balance right will be
important as we go forward in this difficult economic
It is this balance that the competition authorities
will have to seek. Already the clearing issue looks like being
one of its main considerations. Last month, the EU competition
commissioner Joaquín Almunia warned that "analysis of
this operation will not be a simple one".
He added that he "would not be surprised" if the
competition review was extended beyond the initial month-long
investigation. And he made it clear the vertical silo model was
a concern for the Commission.
"From the competition point of view, I tend to
prefer models that are not a vertical silo," he told a hearing
in April. "More open competition, more opportunities, this more
open business model, together with interoperability from the
competition point of view, is preferred."
US regulators have so far not spoken openly on the
issue. However, US Department of Justice raised concerns in
2008 about ICE’s ownership of ICE Clear and one
analyst has said the NYSE deal may revive its concerns.
In a research note released last month, Brad Hintz
of Sanford Bernstein said: "The most important issue facing
these competing offers is the possibility that the ICE/NYSE
Liffe merger will resurrect DOJ concerns with vertical
integration of futures execution and clearing.
"If this issue arises, ICE will likely drop out of
the bidding and the Deutsche Börse deal moves
The clearing issue is greater in the instance of
the Deutsche Börse bid, which would likely result in all
trades on Eurex and Liffe being cleared through Eurex
Mark Spanbroek, former head of business development
at Getco Europe, the US electronic trading firm, believes the
real issue for regulators is not the merger of the exchanges
but the opening up of clearing houses.
"The Deutsche Börse deal is the best for
Europe but regulators must ensure that there is open access to
clearing houses," he says. "They should not be concerning
themselves with the exchange mergers, but with mandating on
open access to clearing. The real battle is in the clearing
There is a precedent here. In 2005, when Deutsche
Börse and Euronext were competing for control of the
London Stock Exchange, a report by the UK Competition
Commission raised concerns over the vertical silo model.
Indeed, in the case of Deutsche Börse, it
suggested a divestment of Eurex Clearing, a requirement that
Eurex Clearing not be used as the provider of clearing services
to LSE, or a "set of behavioural commitments" to prevent it
from denying access to competitors.
Ruben Lee, chief executive of Oxford Finance Group
and author of Running the World’s Markets: The
Governance of Financial Infrastructure, says: "Vertical
integration is portrayed as a big regulatory issue in the cash
markets, but it is just as important in the futures space.
"It is really difficult for a futures exchange to
develop products that compete with existing products traded on
other exchanges if those new products can’t also
be cleared through the same clearing house which clears the
A puzzle for regulators
Merely understanding how institutional and
structural change might work in this market is hard enough
– designing and implementing reforms is a
Despite the Code of Conduct for Clearing and
Settlement, signed in 2006, interoperability remains
underdeveloped. One of the first problems legislators would
have to grapple with is whether two firms trading with each
other would have to choose the same clearing house, or could
each choose a different one.
In the latter case, the two clearing houses would
have to have a connection between them. This is something many
observers are worried about. The point of clearing houses is to
be safe repositories for risk – that security could be
compromised if there was more interlinking with other clearing
houses using different risk management arrangements.
Spanbroek believes regulators should mandate
interoperability in order to open up the exchanges to other
clearing houses. However, this is not an easy task for
regulators – they already have their work cut out
finding a path to clearing for OTC trades.
And in fact even that priority creates problems
with the vertical silo model. Obliging firms to use central
counterparty clearing for certain classes of OTC derivatives is
only likely to work in practice if the exchanges’
clearing houses accept trades conducted elsewhere. That is not
interoperability, but it does open the way for OTC trading
platforms that connect to multiple clearing houses.
As Lee points out, this is tricky territory for
regulators. "If the regulator says that a CCP has to clear
certain products its raises all kinds of issues," he says.
"Some products are not suitable for clearing as they do not
have the right economic characteristics, such as appropriate
levels of liquidity, volatility or standardisation. If a
regulator mandates a clearing house to clear something that is
not suitable to be cleared, there is a danger that in the event
of a default, the CCP will seek public support.
"If a regulator takes the decision to force trades
in particular contracts to be cleared through a clearing house,
in the end the regulator, or the government to which it is
responsible, will be accountable if problems arise from such
Tangled as the NYSE-Börse-Nasdaq-ICE situation
already is, it could get more complicated. Nasdaq and ICE
believe their bid is gaining currency among shareholders
– but other bidders could still enter the ring. CME is
the sleeping giant so far, and speculation is rife as to
whether it will make a play for NYSE Euronext.
Lee says: "We have not yet had a bid from CME, but
in my view it has to bid for Liffe – where else is its
growth going to come from? It is not credible for the CME to
expect significant continued growth domestically, nor can it
expect to be able to grow organically abroad. Liffe is the only
big futures market for sale where foreign ownership could be
"CME might change its attitude to operating cash
markets, but if it does not, it would look to divest the NYSE.
This may mean that Nasdaq could get the cash side, whoever
wins, depending of course on its contract with ICE."
CME Group said it did not comment on
Steve Robinson, a partner at advisory firm PMHK
Partners, says there might also be a bid from Asia.
"It’s a bit early for Shanghai, and Tokyo is
preoccupied with domestic issues, but could Hong Kong throw its
hat in the ring? The Nasdaq bid is a hard one for [Deutsche
Börse] to top but a JV with an Asian provider makes
For the time being, however, NYSE Euronext faces
just one barbarian at the gate and it is sharpening its weapons
to fight off the hostile bid from Nasdaq and ICE.
The exchange’s rationale that the
group is stronger kept in one piece is attractive, but the
financial premium on the break-up bid must also be appealing to
They are likely, too, to think about the lengthy
approval process that might attend the Deutsche Börse
deal. NYSE Euronext has indicated it could take up to a year
before approval is granted. Nasdaq and ICE’s
reverse termination fee shows how bullish they are on winning
And if the EU authorities were to follow their UK
peer’s 2005 suggestion to divest Eurex Clearing in
its analysis of Deutsche Börse’s bid for LSE,
would its board still pursue the deal?
Whatever the outcome, this merger contest is
shaping up to be a long and fascinating process, in which not
only will the fate of several exchanges be decided for several
years to come, but the market is being forced to think afresh
about what structures would really serve it best.