LSE / Deutsche Boerse – what next?

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Over the last couple of days we’ve seen the merger of the LSE and Deutsche Boerse play out in the press to much speculation from various sections of the media, reminiscent of days when super-mergers were more commonplace. What makes this merger so interesting is the potential it has to change the structure of the UK and German markets and potentially European and global flows. Both institutions dominate their home markets and both institutions have complementary ambitions and capabilities. A merger would create one of the largest exchange groups on the planet.
But what does this mean for the wider market? 16 years after the first attempt to merge (and 11 years after the second), the process is still in its early stages and it is unwise to speculate on what a merged entity might look like. We can, however, hypothesise about the various possibilities and what effects that combined entity might have on trading.

Sorting out the technicalities

Given the different structures of both organisations, the way the German and UK markets operate may well be different post-merger. The LSE only runs a trading platform and allows participants to work out their own clearing and settlement arrangements. Deutsche Boerse, however, has verticalised its business and runs clearing and settlement operations as well as a trading platform and insists on participants using these. The new structure has also to be considered under the new MiFID and MiFIR requirements and their implications for any new structure.
The question is which model will the new, merged entity follow? It’s impossible to tell at this stage but vendors and participants must keep a close eye on developments. It’s likely that a change on either side will also force a sizeable change in the market.
The question of geography needs to be addressed. Where will the combined entity be physically located? If both entities are to be amalgamated, where does that leave latency? What about market data feeds?

More efficient markets, lower margin requirements

Along with market structure, we have to also consider what this means for trading. The new merged company will form a single massive pool of liquidity spanning national boundaries and in theory could be positive for the markets. A larger liquidity pool could promote more efficient execution and easier price discovery. In practice, however, much will depend on transaction costs.
One of the other major benefits of a combined LSE/Deutsche Boerse will be the opportunity for netting across the exchanges – especially if we start considering trading beyond equities on the LSE markets. Reduced margin requirements resulting from netting out positions will mean lower margining cost which could in turn mean increased trading. If the LSE moves to expand its derivatives business, the amount of available capital could increase exponentially due to the higher margin requirements of derivatives trading.
Whatever the outcome once the current discussions conclude, it’s obvious that this deal will have far-reaching consequences. Vendors will need to keep a close eye on proceedings if they are to continue to serve their clients well. Perhaps even the pragmatic vendor might think about preparing for the most likely eventuality so that solutions are in place at the moment LSE and Deutsche Boerse make a final decision.

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25 February 2016

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