How Brexit put the brakes on LSE-Deutsche Börse mega merger

The mega merger of London and Frankfurt’s stock exchanges looks in doubt after the London Stock Exchange said the deal was unlikely to be approved by the European Commission. There were a number of reasons why this €29 billion deal could have gone wrong, but Brexit can be blamed if it fails to go ahead at all.

Since the UK’s vote to leave the EU in June 2016 the motives for the merger between the LSE and Deutsche Börse stock exchanges have significantly changed. Prior to Brexit, the main aim was to create a European champion stock index and exchange. This was to take on the major US exchanges of Nasdaq and Intercontinental Exchange (ICE), and in the east, Singapore and Hong Kong exchanges.

But since Brexit, the motives for the shareholders and boards involved has switched to hedging their interests against the decline of London as a financial centre. In effect LSE shareholders would be swapping their LSE shares for shares in the merged business which means they benefit from any transfer of business from London to Frankfurt.

This would have been achieved through the orderly transfer of EU-based activities in London to Frankfurt. The fact that the Deutsche Börse CEO, Carsten Kengeter, would be at the helm of the newly combined index indicates where the power and influence really resides. So the proposed share swap would protect the interests of the LSE shareholders and board who, as a result, would become board members of a much larger international entity. If the merger goes ahead, the new index would be Europe’s largest, giving it dominance within the EU and a strong position in international trading too.

So if this benefits the LSE-Deutsche Börse shareholders and boards then who would have lost out? First, Paris as a financial centre. As a hard Brexit begins to bite, Paris would stand to benefit from a more disorderly loss of London trade. But the conduit of the new index would channel trade that France might have gained directly to Frankfurt.

Clearly the French view is that there must be something in this deal for them. Otherwise it would limit their financial sector to being a minor player both inside the EU and internationally. Hence the manoeuvring to put pressure on the European Commission and specifically its competition authorities to make a last minute demand that the LSE sell its 60% stake in MTS, an important Italian trading platform. This follows on from a demand last year that the LSE divest its French clearing arm LCH, which it agreed to sell to Paris for €510m. It is highly likely that MTS would end up in Paris too.

Trojan Horse

The sale of MTS, according to the LSE board, is a step too far. And London would lose out too much in the long run (as well as the loss of many well-paid London-based employees who would lose their jobs). There has been talk that, while the deal’s agreement was to have the head office in London, as with all undertakings this is likely to be finite. It may well eventually move to Frankfurt in substance, if not name. London as a financial centre could therefore lose out from this Trojan Horse, which would organise and direct trade to Frankfurt. There would be nobody to battle to retain trade in London.

The Bank of England does not have the power to intervene. The government may similarly not have the official powers to prevent the deal – though Prime Minister Theresa May is fresh from her victory over Kraft Heinz and their short-lived bid for Unilever. Greg Smith, the UK’s business minister, made a number of forceful but unofficial interventions which very likely scuppered that move. No one wants to be on the wrong side of a government, particularly one with a long memory of the broken promises from Kraft during their acquisition of Cadbury.

May has not made any moves in relation to the stock market merger, but perhaps she was waiting for the European Commission to rule before acting. Its demands look like they will now prevent the deal. If the merger does end up going ahead, though, then the pressure would surely have been on May to act.