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NYSE Dream of Global Exchange Coming Apart on Derivatives Review

Trail May End in Europe for Exchanges
This combination photo shows Duncan Niederauer, chief executive officer of NYSE Euronext and Reto Francioni, chief executive officer of Deutsche Boerse AG. Photographer: Andrew Harrer/Hannelore Foerster/Bloomberg

A decade-long march by market owners toward greater worldwide scope may be ending in Europe with antitrust regulators recommending against Deutsche Boerse AG’s bid for NYSE Euronext.

Should the deal be blocked, it would mean $37 billion in exchange mergers announced since October 2010 failed to close, according to data compiled by Bloomberg. Stock and derivatives venues completed $28.7 billion of takeovers in 2007 and 2008 as the Chicago Mercantile Exchange purchased rivals Chicago Board of Trade and the New York Mercantile Exchange.

Governments are losing their appetite for the biggest combinations after regulators encouraged them for years as a way to cut costs for investors and improve transparency. Failure by Chief Executive Officers Reto Francioni and Duncan Niederauer to win approval may signal the end of an era in which the biggest exchange companies could buy each other to expand.

“Suddenly, the authorities are unhappy about the actions of profit-motivated exchanges that they at one time encouraged to move to shareholder governance,” Bruce Weber, dean of the Lerner College of Business and Economics at the University of Delaware, said in a phone interview. “They see the size of the combined exchanges as a monopoly-like threat. It’s a paradox.”

Niederauer told NYSE employees on Jan. 11 that it appeared European Commission staff would recommend against the takeover, which has declined 29 percent in value to $6.8 billion since it was announced Feb. 15, Bloomberg data show. The companies are unlikely to garner enough support from commissioners to overturn a looming veto of their proposal, according to four people familiar with the situation.

Exchange Derivatives

Frank Herkenhoff, a spokesman for Deutsche Boerse, said in an e-mailed statement that his company hasn’t received a decision from the European Commission, which will announce its final ruling in early February. He said the company doesn’t comment on speculation. Richard Adamonis, a spokesman for NYSE Euronext in New York, declined to comment.

Deutsche Boerse’s takeover would put more than 90 percent of the European exchange-traded derivatives market in the hands of one company. Eurex, owned by the Frankfurt-based company, is the region’s biggest derivatives venue, while NYSE Euronext’s Liffe in London is second.

Eurex and Liffe accounted for 39 percent of volume traded in the 10 most active exchange-listed interest rate derivatives contracts globally in the first half of last year, compared with 44 percent for CME Group Inc., according to data from the Washington-based Futures Industry Association. Liffe’s Euribor futures was the fourth-most-popular contract, behind CME’s eurodollar futures, CBOT’s 10-year Treasury note and a contract from Brazil’s BM&FBovespa SA.

‘Fundamentally Flawed’

Concessions offered to appease authorities didn’t go far enough, negotiators said at a Dec. 21 meeting, two people familiar with the talks told Bloomberg. The companies offered capping fees on derivatives and clearing for three years, selling NYSE’s Liffe single-stock derivatives business, and the licensing of the Eurex trading system to a third party to allay competition concerns, said the people, who declined to be named because the talks are private.

The proposed concessions “address the EU’s competition concerns and further contribute to the creation of a stable, regulated pan-European exchange infrastructure that would ensure Europe’s competitiveness,” Herkenhoff said in the statement. They would also “deliver significant benefits to participants in the real economy,” he said.

The analysis by European regulators was “fundamentally flawed,” Niederauer told employees. Antitrust officials failed to understand that the derivatives market is global and exchange-traded contracts compete with over-the-counter products, he said. Exchange-traded derivatives were worth about 12 percent of the $708 trillion over-the-counter market at the end of June, Bank for International Settlements data show.

Balancing Needs

Because NYSE-Deutsche Boerse would unite derivatives venues within Europe, regulators face a dilemma they didn’t have with earlier deals such as NYSE Group Inc.’s acquisition of Euronext NV in Amsterdam or the London Stock Exchange Group Plc’s purchase of Borsa Italiana SpA in 2007, Anthony Belchambers, chief executive officer of the London-based Futures and Options Association, said in a phone interview.

European regulators must balance the “establishment of larger, more dominant exchanges to enhance the EU’s global competitiveness” with the ability of rivals to compete within the continent, Belchambers said. The FOA represents European users of futures and options.

Margin Economy

Concerns about competition hinge on clearing, the process where transactions are guaranteed by an entity that becomes the buyer to every seller and the seller to every buyer, reducing the potential harm from a member firm’s default. Most futures exchange operators including Deutsche Boerse own their own clearinghouse and don’t permit similar contracts traded on competing venues to be processed with their own.

Clearinghouses require collateral to back trades, adjusting the amount daily based on a member firm’s positions. When a trader owns two contracts that offset each other’s risk, less margin is required. NYSE Euronext and Deutsche Boerse highlighted the ability to coordinate levels of collateral across a larger pool of products as a benefit of their merger, saying it would save customers $4 billion.

“If you combine clearinghouses you can economize on the amount of margin without taking on greater levels of risk,” Richard Perrott, an exchange analyst at Berenberg Bank in London, said in a phone interview. “The sum of the two is smaller than the two parts.”

‘Vertical Silo’

Joaquin Almunia, the EU’s antitrust commissioner, expressed concern in March that Deutsche Boerse’s deal may monopolize the derivatives market. He cited the company’s “vertical silo,” which routes all trading on its futures platform through Eurex Clearing, and said he favored a “more open business model.” Liffe’s European trades are currently handled by LCH.Clearnet Ltd. in London.

While exchanges seldom gain volume in a futures product traded by a rival, users may prefer having different clearinghouses to ensure that their owners don’t take advantage of their dominance in the contracts, Perrott said. The Chicago Board of Trade was already using the Chicago Mercantile Exchange’s clearinghouse when the companies announced their merger plans in 2006, he said.

Regulators evaluating NYSE Euronext and Deutsche Boerse must also consider the effect of the deal on broker-dealers and investment firms, Belchambers said. Some are concerned the combination “would have a more dominant position in execution, clearing, post-trade services and market data,” he said.


Merging the companies would also reduce technology costs for customers, Belchambers said. It would allow firms to support a single platform and process fewer software updates. The “Catch-22” for regulators, who earlier asked NYSE and Deutsche Boerse to spin off Liffe or Eurex as a condition for approving the deal, is that such remedies could shrink the deal’s benefits to customers, he said.

“Going global requires size, resources and deep pockets,” he said. “You can’t go global unless you are big.” The question for regulators is, “Do we impair the ability of major institutions to make global offerings or not?” he said.

High Barriers

The Association for Financial Markets in Europe, a group of lenders including Switzerland’s UBS AG, Deutsche Bank AG and France’s BNP Paribas SA, said in February that its members “had concerns about potential limits on competition in the derivatives space,” where barriers to entry are high and regulators have pushed for more central clearing. The group told the competition commission in July that the power of the combined company’s “near monopoly” should be curbed.

NYSE Euronext and Deutsche Boerse AG appealed directly to European Commission President Jose Barroso on Jan. 13, arguing that blocking it would “represent a serious missed opportunity at a critical juncture for Europe,” according to a copy of the letter seen by Bloomberg. The recommendation by Europe’s competition panel is subject to a final vote by the full EU.

The Justice Department reached a different conclusion about the Chicago Mercantile Exchange’s takeover of the Chicago Board of Trade in 2007. It found no threat to competition in combining the two largest U.S. futures market operators.


The antitrust unit said in June 2007 that the companies’ products weren’t “close substitutes” and neither exchange was likely to offer products that rivaled those traded at the other because of the difficulty in luring volume from an incumbent futures venue. The regulator saw little risk of fewer new products since the main drivers of innovation were winning volume from over-the-counter markets and devising products those users might adopt to hedge risks.

Craig Pirrong, a finance professor at the University of Houston, said the EU competition commission is overestimating the takeover’s impact on competition for exchange-traded derivatives. The Liffe and Eurex products aren’t “close substitutes for one another” and don’t compete, he said. Regulators should allow the deal, he said.

Larger exchange companies that trade derivatives are moving toward bigger clearinghouses, while regulators “want to move in the other direction,” said Pirrong, who has written about clearing and exchange competition since the mid-1990s. Regulators should figure out how to prevent a clearinghouse from exercising too much power over customers instead of blocking deals that may benefit those users, he said.

Excessive market power at exchanges could potentially be managed by relying on regulators to weed out anti-competitive behavior alongside their market oversight role, Belchambers said. The Financial Conduct Authority, one of the successor organizations to the U.K.’s Financial Services Authority in London, will include the task as part of its mandate to protect investors, he said.

“This is a merger between entities that in the derivatives space have monopolies on their existing products,” Pirrong said. “From a competition perspective, it’s not likely to dramatically increase their monopoly power.”

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