Within weeks of the Deutsche/Euronext tie-up being announced London Stock Exchange bid for Toronto Stock Exchange parent TMX Group and BATS Global Markets said it would buy fellow equities MTF Chi-X Europe. Nasdaq OMX and Atlanta-based Intercontinental Exchange went hostile in a rival bid for NYSE Euronext, and the stage looked set for a red-hot summer of consolidation.
In the event, however, investors were left decidedly underwhelmed. Within weeks political objections emanating from Canada prompted LSE to pull the plug on the TMX deal, while the Australian government scuttled an $8.3bn Singapore Exchange bid to buy Sydney-based ASX
“Both the Canadian and Australian interventions were clearing politically motivated,” says Will Rhode, a senior analyst at Tabb Group. “There is a legacy of connection between national stock exchanges and national identity, and nationalist interest clearly still plays a part in deciding whether proposed mergers will complete.”
In the same month, Nasdaq and Ice shelved their offer after regulators signalled they would block the merger. The move by the US Department of Justice ended what was shaping up to be a bitter hostile bid from the US consortium. The move caught many in the market by surprise coming in the wake of (and perhaps as a result of) confident statements over the success of the deal by ICE and Nasdaq.
Deal or no deal?
One merger which perhaps surprisingly did not meet with a political roadblock was the Deutsche Börse NYSE Euronext deal, the upshot being that among more than $40bn in exchange acquisitions announced in little more than a year, it was one of the only ones still running as the year draws to a close.
However, the plan is not without its challenges, and European antitrust authorities in August raised “significant concerns” over the merged group’s potential dominance of derivatives trading through the combination of NYSE Liffe and Eurex.
The European Competition Commission is currently considering whether the merger would create a monopoly in the derivatives and clearing market, expressing concerning that it would have a "negative impact on innovation in derivatives products and technology solutions”. The result is due out in January.
The anti-trust investigation was doubly significant because of its attention to the issue of post trade competition concerns over the vertical silo model in which both the derivatives exchange and clearing house are run by the same organisation. New regulations running in conjunction with the competition review are focused on this issue (see page 33).
Another concern is the creation of a monopoly for ETD. The proposed combination of Eurex and Liffe would give the group a share of over 90% of European exchange-traded derivatives, and between them they control the third, fourth and fifth biggest US options exchanges. Together with the CME, Eurex and Liffe control around 90% of the most liquid exchange-traded derivatives.
Rivals have fought the proposed tie up. Leading the charge has been LSE-owned Turquoise, which has made no secret of its objection to the ownership by exchanges of companies of rights to stock indices, such as Deutsche Börse’s ownership of the Stoxx index.
Deutsche Börse and NYSE Euronext argue that their derivatives combination would face significant competition from over-the-counter derivatives markets and that a large European exchange would act as a counterbalance to CME in a global industry.
In a move that may ironically help the merger along, Nasdaq OMX Group said in October plans to set up a European derivatives trading platform based in London. However, attempts by Turquoise to break into the European equity index market have reinforced its argument with just 4133 FTSE 100 futures contracts, launched in competition to NYSE Liffe, traded in the six months since their June launch.
Strong results
But while the derivatives business is the main area of concern for the European authorities, it is also the jewel in the crown of the deal. Revenues from cash equities are under threat from the proliferation of MTFs and are no match for supercharged revenue generator that is derivatives trading, a business line that is set to grow exponentially over the coming decade as legacy over-the-counter businesses are migrated onto more transparent electronic trading facilities.
The power of the derivatives business was illustrated by the earnings reports of Nasdaq OMX, NYSE Euronext, Deutsche Börse and Intercontinental Exchange over the past year. The four major exchange groups all reported jumps in earnings in 2011, fuelled by increases in trading of derivatives.
The performance of Nasdaq OMX was typical of the upbeat mood, after the exchange posted record results for the third quarter, with revenues reaching an all time high of $438m. Net income grew to $121m, from $92m in the second quarter of 2011 and $101m in the third quarter of 2010.
Nasdaq attributed much of its improved performance to increases in trading volumes in derivatives, to which it is shifting its focus. ICE also reported bumper third quarter results, with consolidated revenues rising 19% from the third quarter of 2010 to a record $341m.
“What makes these exchanges such valuable businesses is that fact that derivatives markets, and in particular standardised contracts, are moving to them from the over the counter space,” said David Donovan, a vice president at Sapient Global Markets. “There is no doubt there is a lot of money to be made there over the next decade.”
Amid the waste land of this year’s failed bids, there have been some successes, however. Shares in TMX, owner of the Toronto Stock Exchange, rose in recent weeks to near the level bid by the Maple Group consortium, which moved for the exchange as a rival for the LSE bid in May. Questions remain over the deal, however and its completion is no means from certain.
What is of concern to regulators is the monopoly that Maple Group would have in the Canadian markets if the bid for TMX is successful. The deal would see Canada’s leading MTF, Alpha, and Canadian Depository for Securities merged with TMX Group. However, the deal remains on the table for now.
Another success story is the $4.8bn merger of Russia's Micex Group and RTS, the FORTS unit of which is rated among the top 10 global derivatives exchanges, which is moving steadily towards completion. The deal is set to be completed before the end of year, and will create in Moscow a regional trading hub for the former Soviet republics, eastern Europe, parts of Asia and the Middle East.
And with the LSE bid for LCH.Clearnet and the London Metal Exchange currently preparing to receive offers, more deals could complete in 2012 than this year. Over the past few weeks, new deals have emerged, including news that Tokyo Stock Exchange Group has entered late-stage talks to buy Osaka Securities Exchange.
“The evidence is that local consolidation, often driven as was the case in Russia by governments, is a lot easier to progress than regional transactions,” said Tabb Group’s Rhode. “Those ahead of the game see consolidation as an international trend, while those slightly behind the curve are still focusing on national concerns.”
2011 was a year of failed mergers and given the mixed picture for mergers in 2012, it would be unreasonable to predict another wave of consolidation for the coming 12 months. However, the economic rationale to consolidate will only intensify in the coming years. In addition, a possible spin off of part or all of the equities division of Liffe might be a caveat of the NYSE DB tie up, a move that would spark a bidding frenzy from rival exchanges such as the LSE or ICE. Once again, it is shaping up to be an interesting 12 months.