European stock exchanges. Seifert’s second proposal

Deutsche Borse's fresh approach to the London Stock Exchange

CAN he do it this time? In 2000 Werner Seifert, chief executive of Deutsche Borse, first tried a merger with the London Stock Exchange (LSE). That effort ended in a chauvinistic wrangle with the LSE's owners. Since then a pile of cash has been burning a hole in Mr Seifert's pocket as he looks for sensible things to buy. In early 2002 he took full ownership of Clearstream, a securities depository, for €1.6 billion (then $1.4 billion). In August of this year he approached SWX, a Swiss stock and derivatives exchange group, but did so clumsily and was rebuffed.

Since then Mr Seifert appears to have gone to charm school in order to win over Clara Furse, chief executive of the LSE. In the past few months he has often been seen in the City of London, apparently preparing the ground for a new approach. On December 13th the LSE confirmed that over the weekend Mr Seifert had proposed buying it, although he has not yet made a formal bid. Ms Furse said that the price, valuing her exchange at just under €2 billion, was too low and that the terms were too vague. Still, the two sides are in talks.

If the deal hatched in 2000 between Deutsche Borse and LSE had gone ahead, it would probably have been a disaster: for instance, all blue chips were to be traded in London and all high-tech stocks - whose prices subsequently collapsed - in Germany. However, since then much has changed in the highly technical, competitive businesses of securities exchanges, clearing and settlement. Both Deutsche Borse and Euronext, a rival European exchange group, are vertically integrated, with clearing and settlement “silos” attached to trading facilities. Margins on clearing and settlement are now so thin that there is little scope for profitable growth. Analysts are returning to the view that growth will now come at the sharp end: in the trading of shares, and in the provision of liquidity and a means of discovering the best prices quickly. This is what draws new customers to exchanges, driving up volumes and creating bigger trading networks.

On this view, the LSE, with its wide international connections, its web of brokers and end-users, and its loose alliance with clearing and settlement partners, is quite a prize. Following Mr Seifert's offer at the weekend, many observers expect Jean-Franois Theodore, chief executive of Euronext, to make a counter-offer. Sweden's OMX, whose rival bid for the LSE in 2000 helped ruin Mr Seifert's previous merger plan, has said nothing, but is thought unlikely to act this time.

Even before the German offer, analysts had predicted that Euronext would bid for the LSE sooner or later, almost out of desperation. Euronext's third-quarter results were poor. Its four stockmarkets, Paris, Amsterdam, Brussels and Lisbon, could do with extra liquidity. Mr Theodore therefore needs the LSE more than Mr Seifert does; but Mr Seifert has deeper pockets.

Whether the LSE is bought is not just a matter for shareholders; regulators will be watching too. One old lot of watchdogs' worries, about Deutsche Borse's and Euronext's vertically integrated structures, has already been more or less overcome. Regulators have been able to force clearers to grant access to outsiders on equal terms - as, for example, when Euroclear, an international securities depository, complained about exclusion by Clearstream. In time, every combination of trading platform, clearing house and securities depository will probably be open to all in Europe at rock-bottom prices.

Still, there are matters of concern. One is pretty basic: how would a merged Deutsche Borse and LSE be regulated? The German group is largely supervised by the economics ministry in the state of Hesse, not an obvious choice as lead regulator. However, that may not matter if London's Financial Services Authority remains the LSE's main supervisor.

Another worry is that the exchanges' owners, rather than its share-trading customers, will reap most of the efficiency gains to be had from the merger. An Anglo-German merger should benefit the LSE's members (banks and brokers) through cost reductions when London and Frankfurt develop a common trading system, probably in around three years' time.

Whether some of those savings, estimated at 15-20%, will then be passed to investors using the exchange to buy and sell shares is a matter of competition, regulation and even politics: governments trying to encourage private pension investment would surely welcome lower trading charges. Yet the marriage of two of Europe's three biggest exchanges brings the risk that price competition will be reduced.

Experience suggests that prices are forced down only when newcomers invade an established exchange's turf. So it was when Tradepoint, an upstart electronic exchange now called virt-x, attacked the London blue-chip market in 2000; when the LSE opened trading in Dutch blue-chips this May; and when Eurex, a derivatives company owned by Deutsche Borse and SWX, took on Chicago's futures exchanges in February. Regulators will want to be sure that outsiders can keep the incumbents on their toes.

If Deutsche Borse does take over the LSE, European exchanges will appear to be arranging themselves around two hubs. Euronext owns Liffe, the London derivatives exchange, and has links with the Warsaw bourse. Deutsche Borse already has ties to Dublin, Helsinki, Vienna, Budapest and (via Eurex) SWX. LSE has a small derivatives exchange in London, EDX, a joint-venture with OMX. Through a joint-venture with the Financial Times, it co-owns the FTSE share-index trademark. At present Euronext has a licence to trade FTSE index futures. Eventually these may find their way to EDX or Eurex.

Over the past five years, exchanges have seen great changes wrought by electronic and information services. In the next five, they are likely to see as much again. Exchanges are looking fearfully at the screen technologies now being offered by inter-dealer brokers and information providers. With some systems, customers can hit the best price of those appearing on their screen almost regardless of the source. Such “price aggregation” may come to make a nonsense of geography and of which exchange owns what.

That could make further consolidation pointless; or it could produce more deals as exchanges try to preserve their power. That might mean transatlantic mergers too. Among the bolder forecasts doing the rounds is that a Chicago derivatives exchange might join forces with one of the European hubs. For now, though, Mr Seifert's mind is on the LSE.

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