London Stock Exchange Group plc.; market cap as of 04/03/2016: £9.93bn ($14.13bn)
Intercontinental Exchange, Inc.; market cap as of 04/03/2016: $28.41bn
Deutsche Boerse AG; market cap as of 04/03/2016: €14.31bn ($15.74bn)

 

Introduction

Last week’s rumors about a “merger of equals” between LSE and Deutsche Boerse officially put LSE “in play”. Such an event raised the attention of the colossus Intercontinental Exchange which is expected to launch a bid for the London based company. An eventual merger of this kind would even expand the $30bn US company’s empire having London and New York as its foci.

Since ICE is facing regulatory hurdles, it will probably have to make a consistent offer if it is to obtain London’s biggest exchange asset. However, the rationale behind the acquisition may be strong enough for the American firm to advance such a bid. Indeed, global regulations have forced banks to place billions as collateral to back their positions on derivatives. As a consequence, huge amounts of cash are held at clearing houses. Were clearing houses to merge, customers will be able to net their margins for swaps and futures.

It is clear that this rationale does not apply to the specific ICE – LSE case but to all exchanges that consider merges as a possibility. Given this context we expect to see a fierce rivalry between DB, ICE and other players such as CME in order to place the best bid for the London based target company.

A bidding war is certainly not good news for Deutsche Boerse since its balance sheet is already burdened and a revision of its bid would involve a larger proportion of the merged entity’s equity going to LSE shareholders.

Moreover, the size and diversity of LSE’s business may create potential issues to bidders. It is therefore likely, in case of an acquisition, that parts of the business are spun off to ease the deal.

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About London Stock Exchange Group plc.

With Total Assets amounting to £500bn London Stock Exchange Group (LSE.L) is a diversified international market infrastructure and capital markets business headquartered in London but with significant operations in North America, Italy, France and Sri Lanka. The Group was created in October 2007 when London Stock Exchange merged with Milan Stock Exchange, BorsaItaliana.

LSE group operates a broad range of international equity, bond and derivatives platforms, including London Stock Exchange; BorsaItaliana; MTS; and Turquoise, a pan-European equities MTF. It is also home to one of the world’s leading growth markets for SMEs, AIM.

Acting as an intermediary between players in the marketplace is not the only aim of the Group. Indeed, LSE offers a full range of Post Trade services, providing risk management and efficiency for traders both in Italy and in the UK. The commitment of the Group toward a diversification of its offer appears clear if we look at the number of acquisitions it made in its recent history. These acquisitions led the London based company to have majority ownership of clearing services in the UK, continental Europe and the US.

Moreover, following the acquisition of Frank Russell Company at the end of 2014, the Group became a global leader in indexing and analytic solutions. FTSE Russell offers thousands of indexes that measure and benchmark markets around the world.

The Group also supplies real time prices and trading data, creating the transparency and liquidity that are essential for market users. Data is not only provided directly to clients, it is also distributed through providers such as Bloomberg and Thomson Reuters. This scope is performed through an extensive range of data products, including SEDOL, UnaVista, and RNS.

 

About Deutsche Boerse AG

Headquartered in the financial centre of Frankfurt, Deutsche Börse Group, with €216bn of total assets, is one of the largest exchange organizations worldwide. As the LSEG, it organizes platforms for investors that are looking to invest capital and for companies that raise capital. Deutsche Börse Group, ensures the correct functioning of these markets and a level playing field for all participants worldwide.

Deutsche Börse has an integrated business model. The products and services the company offers are broader than other exchange organizations as it covers the entire process chain. Its business areas range from the admission of securities to listing, through trading, clearing and settlement, down to Custody of securities and other financial instruments as well as collateral management. Moreover, Deutsche Börse provides IT services, indexes and market data for its trading platforms worldwide. With more than 4,540 employees (as of 31/12/2014) it is also globally present: in Luxembourg, Prague, London, Zurich and Moscow, in New York and Chicago, in Hong Kong, Singapore, Beijing and Tokyo.

 

About Intercontinental Exchange, Inc.

Founded in 2000 with the aim of creating an Internet-based platform to provide a more efficient market structure for OTC energy commodity trading, Intercontinental Exchange, Inc. (ICE) is an American network of exchanges and clearing houses for financial and commodity markets. ICE owns and operates 23 regulated exchanges and marketplaces; ICE futures exchanges in the US, Canada and Europe, Liffe futures exchanges in the US and Europe, NYSE, Equity options exchanges, OTC energy, credit and equity markets. ICE also owns and operates 5 central clearing houses; ICE Clear Europe, ICE Clear U.S., ICE Clear Canada, ICE Clear Credit, and The Cearing Corporation. The company accounts for $80bn Total Assets.

Similarly to that of the LSE Group, ICE’s leadership worldwide derives from a number of acquisitions that the company carried out over its recent history. In particular, after it became a publicly traded company on November 16, 2005, and was added to the Russell 1000 Index in 2006, the company used M&A to expand rapidly. Among the other purchases, in 2007 ICE acquired the 120-year-old Winnipeg Commodity Exchange for $40m which has subsequently been renamed ICE Futures Canada; in 2013 it acquired NYSE Euronext for $8.2bn and in 2015 Interactive Data Corporation for about $5.2bn.

Below is a comprehensive summary of the exchanges controlled by the major players in the industry.

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Deutsche Boerse – London Stock Exchange

The proposed deal

Despite the interest for the London Stock Exchange recently expressed by some major Exchanges including ICE, Deutsche Boerse remains the most likely candidate for the merger with the British company.

Talks between Deutsche Boerse and LSE started just after Christmas but have ramped up in recent weeks. In February the two exchanges announced plans to combine and create a global player worth at least 20 billion pounds ($28bn) which could better compete with the major exchanges such as ICE, CME Group and Hong Kong’s HKEx. Under the terms being discussed, the new company would be domiciled in the UK and established as a PLC (Public Limited Company). The new group would have operational headquarters in London and Frankfurt, and be dual-listed on the main stock market in both cities. The companies stressed the balanced nature of an all-share “merger of equals”, this would ideally underscore the political sensitivities and regulatory scrutiny of the deal. Deutsche Börse would emerge with 54.4% of the new entity and LSE investors would own the remainder (even though given the latest surge in LSE’ stock prices the ratio might ultimately be different). Namely, shareholders would receive  0.4421 Deutsche Börse shares for each LSE share they own, under the current talks. Xavier Rolet, CEO of the LSE, said that the “merger of equals” was based on a three-month simple average of both companies share price. Moreover, spokespersons also confirmed that Mr. Rolet would step down from his role. The new group would be run by Carsten Kengeter, who has headed up Deutsche Börse since June, and who would also be a member of an equal-weighted board. Donald Brydon, the LSE chairman, would hold the same role in the new company while David Warren would be the Chief Financial Officer of the company.

Synergies

Although news of the deal came out just after the UK set out a timetable for possible exit from the European Union, the two companies firmly sustained that the rationale behind the merger remains 100% commercial.

The merger would allow “substantial” cost cuts. Cost synergies will likely come from management and support functions of the combined entity, whereas revenue synergies would arise from the cross-selling of products, for instance the combination of FX clearing within LCH.Clearnet and 360T (Deutsche Börse’s FX trading business).

Yet, the key point is that the merger would allow customers (Investment Banks in particular) to benefit from cross-margining between listed and OTC derivatives clearing. In fact, new rules are forcing banks trading in derivatives to post large amounts of collateral and margin as insurance to back their deals at central clearing houses. As a result, billions of dollars of capital are being held at clearing houses such as Deutsche Börse’s Eurex and LCH.Clearnet. However, bringing them under one roof would allow customers to net their margin for swaps and futures.

Anti-trust issues

A potential deal between exchanges of this size would undoubtedly face antitrust scrutiny, particularly from the European Commission. However, although the new company would be by far Europe’s largest exchanges operator, LSE and Deutsche Boerse offer relatively different services and rarely compete on the markets. Indeed, the LSE’s strength, besides clearing, lies in share trading and the provision of data for markets to asset managers and hedge funds. By contrast, Deutsche Börse focusses on trading and clearing futures, and settlement and custody of securities.

German Chancellor Angela Merkel’s government has already confirmed its support to the proposed fusion which according to its spokesperson will create a European powerhouse that could better compete with bigger U.S. rivals. On the other hand,  German lawmakers may not be equally accommodating. SPD lawmaker Ingrid Arndt-Brauer, head of the Finance Committee in the lower house of parliament, told Bloomberg on February 23 that, further investigation on the deal’s rationale are required and she would withdraw her support in case the merger turned out to be a “safety net” for London in the case of a Brexit.

Street sweep”

According to Bloomberg, LSE Group and Deutsche Boerse have gone on a hiring spree for banks in a so-called street sweep, as they try to fend off interlopers to their European exchange merger by hiring advisers. LSE, whose lead adviser in the transaction is Robey Warshaw, is in the process of signing up additional banks including Goldman Sachs, JP Morgan, Royal Bank of Canada, UBS Group AG, Barclays and Societe Generale.

On the other hand, Deutsche Boerse, whose main adviser on the deal is Perella Weinberg, is also close to retaining Deutsche Bank, Bank of America and HSBC.

 

ICE to join the bidding

The rationale for ICE’s bid is similar to the one that drives the Deutsche Börse deal. Once again the rationale of the deal would be found in derivatives clearing as there ought to be “significant cross-margining opportunities”. Namely, a combined exchange should tie up less collateral — and less capital for the banks. ICE’s takeover of LSE would add to its London market infrastructure as it already owns futures trading, clearing and data businesses in the City. On the other hand, ICE has an effective tax rate of c.21% so it might also be contemplating a tax inversion. It is just one way that could help it finance a cash component in its potential offer for LSE. ICE’s net debt stands at c.3x its historic EBITDA. Moreover, the takeover of LSE by ICE could drag two spinoffs with itself. Actually, LSE considered spinning off its French clearing arm, LCH.Clearnet, even with its initial plans with Deutsche Boerse, in order to gain support from regulators and politicians for a deal. The LSE owns 58% of LCH, with the balance owned by a consortium of banks. Euronext, which ICE spun off two years, could be interested in purchasing Clearnet. Moreover, if ICE makes the bid for LSE, their plans could also include spinning off Borsa Italiana. This move should also help ICE finance a move for the LSE.

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