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European Commission blocks LSE-Deutsche Börse merger

The European Commission has prohibited the proposed merger between Deutsche Börse and the London Stock Exchange (LSE) under the EU merger regulation.30 Mar 2017

The proposed merger would have combined the activities of the two largest European stock exchange operators, which between them own the stock exchanges of Germany, Italy and the UK, as well as several of the largest European clearing houses, the Commission said.

The Commission's investigation concluded that the merger would have created a "de facto monopoly in the markets for clearing fixed income instruments", it said. The merger would have combined Deutsche Börse's Frankfurt-based clearing house Eurex with the LSE's clearing houses LCH.Clearnet, which comprises London-based LCH.Clearnet and Paris-based LCH.Clearnet, and Rome-based Cassa di Compensazione e Garanzia.

This monopoly would have had a knock-on effect on the downstream markets for settlement, custody and collateral management, the Commission said.

"Service providers in these markets depend on transaction feeds from clearing houses. As Clearstream competes with these service providers, the merged entity would have had the ability and the incentive to divert transaction feeds to Clearstream and foreclose the other competitors," it said.

The merger would also have removed horizontal competition for the trading and clearing of single stock equity derivatives, based on stocks of Belgian, Dutch and French companies, the Commission said.

"Currently, Eurex competes with a bundled product offered by Euronext and LCH.Clearnet. After the merger, LCH.Clearnet, which has significant pricing power over the bundled product, would have less incentive to compete with Eurex. Finally, this market power could potentially also be used to squeeze out Euronext," it said.

LSE and Deutsche Börse had proposed that the LSE sell LCH.Clearnet to address these concerns. The Commission agreed that this would have resolved its concerns about single stock equity derivatives, but said it would not have been enough to remedy concerns about the de facto monopoly in fixed income clearing.

LCH.Clearnet's fixed income clearing business depends on trading feeds from LSE's fixed income trading platform MTS. The Commission had asked LSE to divest MTS, but "the parties were, however, only prepared to offer a complex set of behavioural measures but not the divestiture of MTS", it said.

The LSE said last month that this condition was impossible to meet within the deadlines set.

The LSE "tested thoroughly the feasibility and implications" of the "disproportionate" request, and concluded that it would not be able to meet the deadline for putting together a proposal on the sale.

MTS is a "systemically important regulated business in Italy due to its significant role in the trading of Italian government bonds and other securities," the LSE said.

"Any change of control of MTS would require, in particular, the approval of the Italian authorities and would trigger parallel regulatory approval processes in other jurisdictions including the UK, Belgium, France and the USA," it said.

After discussions with the Italian authorities, the LSE board believes it is unlikely that a sale could be achieved satisfactorily, "even if LSE were to give the commitment", it said.

The remedy would be likely to jeopardise LSE's relationships with the regulators and be detrimental to its ongoing businesses in Italy and the combined group, it said.

Competition expert Guy Lougher of Pinsent Masons, the law firm behind Out-Law.com said: "The experience illustrates well the difficulties in agreeing an effective and comprehensive set of structural remedies in complex transactions. It is also a clear reminder of the European Commission’s strong preference for structural, rather than behavioural, remedies as a means of resolving competition issues arising on a transaction."

Jonathan Beastall, also of Pinsent Masons said: “Clearly a huge amount of time and expense will have been incurred in progressing this deal. The Takeover Code was changed in 2011 to prevent targets from paying break fees on deals but it is still permissible, in certain circumstances, for a bidder to pay a reverse break fee to a target and this sometimes happens when the target is concerned about anti-trust clearances being obtained. This deal was billed as a merger of equals so break fees were never in point but from a general perspective it can be seen that allocation of risk in a takeover situation where anti-trust clearances are of concern, or where structural rather than behavioural remedies might be required, needs careful consideration by both parties.”

Deutsche Börse is best known for operating the Frankfurt Stock Exchange but also runs other regulated exchanges, most notably the Eurex and EEX exchanges, trading various types of derivative products. Apart from trading its activities include the supply of post-trade infrastructure services such as clearing, settlement and custody services.

LSE operates the London Stock Exchange but also owns Borsa Italiana, the Italian stock exchange, and operates a number of other trading platforms for trading of stocks, other equity-like exchange traded products, bonds and derivatives. LSE is also active in the post-trading space, most notably in clearing through the London Clearing House and through Cassa di Compensazione e Garanzia, the Italian clearinghouse.

The exchange operators agreed on the proposed £21 billion merger in February 2016, and recommitted to the deal the day after the UK referendum on 23 June. Shareholders of the LSE then "overwhelmingly" voted to approve the merger on 5 July.

Shareholders in Deutsche Börse gave approval for the planned merger in July 2016, after Deutsche Börse lowered the minimum acceptance threshold to make sure that the vote succeeded.