CME Merger Talks Raise Fee Concern That May Stymie Deal
The world’s second-largest exchange operator by market value approached Frankfurt-based Deutsche Boerse about beginning discussions for a merger at the end of 2012, before Intercontinental Exchange Inc. announced plans to buy NYSE Euronext on Dec. 20, according to four people familiar with the situation. Deutsche Boerse, which had its deal with NYSE blocked by European antitrust regulators, is hesitant about entering talks, the people said. The German company said in a statement it’s not in merger talks.
While a deal may yield “significant cost savings” through shared systems for trading and clearing, firms that do business on the Chicago and Frankfurt exchanges may balk at a merger that could increase their costs, Niamh Alexander, an analyst at KBW Inc., said in a report. Diego Perfumo, an analyst at Equity Research Desk LLC, an advisory firm with hedge fund clients, said any combination would face political hurdles.
“CME would be taking over half of the European derivatives market and some member banks may like it and some wouldn’t,” Perfumo, based in Greenwich, Connecticut, said by phone. “CME is a very strong competitor and they’d see CME concentrating more and more power, first in the U.S. and then globally.”
Anita Liskey, a spokeswoman for CME, declined to comment about the company’s plans. Terrence Duffy, executive chairman of CME, declined to comment on merger “speculation” in a CNBC television interview today.
Acquiring Deutsche Boerse would give CME the Eurex futures exchange, the largest by number of contracts traded in Europe. Eurex’s main competitor is NYSE Euronext (NYX)’s London-based Liffe market. Deutsche Boerse shares slipped 2.7 percent yesterday after climbing 5.6 percent on Feb. 25.
ICE (ICE), as Intercontinental Exchange is known, said in December it plans to keep Liffe and NYSE Euronext’s U.S. securities markets including the New York Stock Exchange while exploring an initial public offering of the European stock venues once the merger is completed. The New York-based company runs share exchanges in Paris, Amsterdam, Brussels and Lisbon.
A deal between CME and Deutsche Boerse would reduce costs by combining technology and trading and clearing systems, Perfumo said. CME could structure it similarly to ICE’s, selling the cash equities exchanges and keeping businesses that overlap, he said. Getting management and regulators to agree to breaking up Deutsche Boerse wouldn’t be easy, he said.
Both companies trade futures on interest rates, commodities and equity indexes, KBW’s Alexander said. Still, appeasing futures brokers and other members worried that their trading and clearing fees could rise might be a challenge.
“We don’t believe that the member customers would sit as comfortably with a merged CME/DB1 given the power that this combined entity could have over significant global interest rate futures,” Alexander wrote, using the ticker symbols for the companies. Merging the futures clearinghouses, which could reduce the collateral customers provide to secure trades, isn’t a “foregone conclusion” since they operate in different jurisdictions with different bankruptcy laws, she said.
As Deutsche Boerse and NYSE Euronext negotiated with regulators in 2011, customers represented by the Association for Financial Markets in Europe raised seven areas for antitrust scrutiny with the European Commission.
The group, representing banks and brokers including Goldman Sachs Group Inc., Bank of America Corp., Deutsche Bank AG and UBS AG, argued in submissions to regulators that competition in exchange-traded derivatives and clearing would be stifled by the merger. James White, a spokesman for AFME in London, said the organization had no immediate comment.
CME’s revenue from clearing and transaction fees declined 9 percent to $545 million in the fourth quarter compared with the same period in 2011, the company said in a statement on Feb. 5. It earned 83.1 cents per contract, up 2.5 percent from the earlier period, it said.
Discussions between CME and Deutsche Boerse could lead to an alliance in which shares are exchanged though not enough to alter control, Perfumo said. Such a transaction could be modeled on CME and BM&FBovespa SA (BVMF3)’s pact in which the Chicago and Sao Paulo-based exchange companies own minority stakes in each other. CME and the Brazilian equities and futures exchange operator own about 5 percent of one another’s shares, according to data compiled by Bloomberg.
An alliance in which “the two companies develop products together, leverage their own distribution, link their clearinghouses to the extent regulators allow and have a stock swap” would be easier to negotiate than a breakup of Deutsche Boerse, Perfumo said.
Exchange companies around the world have been the subject of takeover bids amid shrinking profits for securities trading, leading to the $8.2 billion offer for NYSE Euronext by ICE, a 12-year-old energy and commodity futures markets operator in Atlanta.
The 2011 bid for NYSE Euronext by ICE and Nasdaq OMX Group Inc. (NDAQ), rejected by the U.S. on concern the combination would dominate American stock listings, is part of a three-year, $50 billion wave of attempted exchange deals, most of which haven’t been consummated.
CME and Deutsche Boerse could achieve “economies of scale, increase market share, offer a broader mix of products and try to get a bigger share of institutional trades on their platforms,” Peter Kovalski, an analyst and portfolio manager at Alpine Woods Capital Investors LLC in Purchase, New York, which oversees about $6 billion, said in a phone interview.
“CME is the premier name for derivatives in the U.S.,” he said. “A deal can be struck but the question is, can it be approved, because it ends up becoming a political hot potato.”
Equity derivatives trading fell last year for the first time since 2004 as volatility subsided, according to a report by the World Federation of Exchanges. Volume in futures and options on stocks and equity indexes dropped 20 percent and interest rate products declined 17 percent, the report said.
More than a decade after it went public, CME may have missed its chance to acquire a European derivatives exchange. Deutsche Boerse is the third company with operations in Europe that CME, under the leadership of Phupinder Gill, examined in the last year. It bid on the London Metal Exchange and talked to NYSE Euronext about the clearing and Liffe businesses, according to people familiar with the matter who asked not to be named because the talks were private.
Jeffrey Sprecher, the chief executive officer of ICE, also submitted a takeover bid for the LME. Hong Kong Exchanges & Clearing Ltd. (388), which at $20.4 billion is the largest among its peers, bought the metals market in December.
The U.K. is “pretty much the only jurisdiction where there have been big exchanges and where the politics would allow them to be bought by foreign companies,” Ruben Lee, chief executive officer of Oxford Finance Group, a London-based consulting company specializing in financial and commodity markets, and author of “Running the World’s Markets: The Governance of Financial Infrastructure,” said by phone. “The CME was in the bidding for LME. The possibility of buying Liffe was always there, it’s just that Sprecher took the opportunity.”
ICE bought the International Petroleum Exchange in 2001 and acquired the New York Board of Trade in 2007. CME purchased the Chicago Board of Trade that year and New York Mercantile Exchange in 2008. It added the Kansas City Board of Trade to its slate of exchanges in December.
“Both of these exchanges have shown an ability and interest in acquisitions,” Bruce Weber, dean of the Alfred Lerner College of Business and Economics at the University of Delaware, said in a phone interview. “CME sees the ICE acquiring NYSE Euronext and being innovative playing the merger game and they don’t want to fall behind.”
Antitrust concerns may not hinder a combination unless the so-called vertical model of futures exchanges, in which the market operator owns both the trading platform and clearing operation, prompt regulators to condition approval on a remedy such as spinning off a clearing business, Weber said. CME and Deutsche Boerse are the “poster children” for the vertical model, he said.
The European Commission blocked Deutsche Boerse’s takeover of NYSE Euronext in February 2012 because a combination would have put 90 percent of European exchange-listed derivatives trading in the hands of one company. Since then, several companies, including CME and New York-based Nasdaq OMX, have said they plan to introduce new markets to trade futures in Europe.
Another hurdle for a deal between the U.S.’s CME and Germany’s Deutsche Boerse is which company would have the upper hand, Oxford Finance Group’s Lee said. CME market value is $19.5 billion compared with $12.1 billion for Deutsche Boerse.
“This would be a much bigger cultural challenge for merging the two institutions than acquiring NYSE Euronext,” he said. “Given that you can never have a merger of equals, one would have to be on top and it’s difficult in the current context to see either one being happy not being in this position.”
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