The politics of the LSE-Deutsche Börse Merger amid Brexit uncertainty
12 juillet 2016
The financial sector is experiencing a broad trend of centralisation and standardisation. Financial regulation itself encourages the consolidation of stock exchanges. An array of peer-to-peer contracts that were beyond the scope of stock exchanges and clearing houses now have to go through standardised clearing processes so as to support the illusion of stability and liquidity in a context where financial markets are flooded with central bank money.
The merger between the London and Frankfurt exchanges follows a clear financial and commercial logic in this respect. It is supposed to allow the combined entity to cut operating costs by up to 30 percent and to offload more than 1,000 jobs once the merger is completed. It is aimed at increasing the competitiveness of this new European exchange amid fierce global competition, as London strives, among other things, to secure its status as the yuan’s main trading centre outside Asia.
Meanwhile there is a geopolitical dimension to this deal. London is the financial centre of the European Union and in some way of the eurozone due to the extent of trading in euro-denominated derivatives there. This is an embarrassment to European institutions and especially to the ECB, which has tried over the years, long before the Brexit vote, to repatriate the financial activities and the clearing services surrounding these contracts to its jurisdiction, the eurozone. However, the EU’s judicial system has upheld London’s position on this issue, in virtue of the single market’s rules, which apply to capital markets throughout the EU, not only in the eurozone.
London is therefore keen to create a closer link with continental stock exchanges, Frankfurt in particular, in order to confront these attacks, which can only intensify in the context of Brexit. On the German side, a number of objections have been raised against the merger. Yet Germany’s Finance Minister, Wolfgang Schäuble, has adopted a relatively amenable stance to the merger. Generally speaking, Germany has every interest to keep the United Kingdom in the single market so as to preserve its large exports there. Conversely it is crucial for the UK as a whole, which already suffers from a very large trade deficit (with a current account deficit close to 6 percent in 2015) to retain the right to sell its financial services throughout the EU. The need to attract investments is the financial partner to the trade deficit, of which the property bubble is a key driver. In a sense, with the ongoing tension, all the traditional ingredients of a currency crisis are there. The pound’s depreciation is not a problem in itself. It even helps, to some extent, to restore the competitiveness of Britain’s industry after a long period of overvaluation. The problem lies in the dynamics of capital outflows and financial drying-up that depreciation fuels, as exchange rates tremors usually help deflate bubbles in a chaotic way.
In this regard any concrete disruption of the UK’s participation in the single market, in terms of trade and capital markets, would result in a genuine financial upheaval due to Britain’s dependency on its financial sector and foreign investments. The current market period of instability would retrospectively appear as a mere prelude if that were the case. That outcome would be in no European country’s interest, whatever their competitive goals.
What does the decision to have dual headquarters, in London and Frankfurt, reveal? Is this merger going to marginalise the Paris stock exchange and Euronext?
The idea of the double headquarters has come to the fore with the difficulties related to Brexit. The plan initially worked out and submitted to the shareholders favoured London headquarters while allowing Deutsche Börse’s CEO to head the conglomerate. The Brexit vote has changed this situation and prompted fears that Europe’s largest bourse would be managed from outside the European Union. It is this aspect which matters particularly since Amsterdam has also been mentioned as a possible host.
The British side strives to secure their financial and commercial position within the single market and retain London’s status as Europe’s financial centre. Beyond mere trade issues, Britain’s macro-financial stability is at stake because of the imbalance that undermines its economic model and the unintended consequences of the housing bubble. In Germany, while the government, and in particular Wolfgang Schäuble, has been rather supportive of the merger proposal and has shown an interest in the project, a portion of the political establishment, especially at the local level, remains opposed to the plan.
Diverging voices were also heard in France, whose government has stated its opposition to the merger and its desire to take advantage of Brexit and help its financial sector to gain new market shares. The Germans have opted for a starkly different strategy. As they understand that Frankfurt is not seen as a credible alternative to London as Europe’s main financial centre, even if London eventually left the single market, the German authorities rather tend to promote an association between London and Frankfurt.
Brexit was instrumental in the merger, since the European Commission would probably have dismissed it on the ground of abuse of a dominant position? Is it also a response to the economic consequences of Brexit?
The project of a merger between Frankfurt’s and London’s exchanges predates the British people’s vote to leave the European Union. The negotiations took place during the Brexit campaign, at a time when most observers believed that “remain” would prevail. So there was already a strong strategic interest in linking the two exchanges, particularly as London was threatened by its status outside the eurozone. At that time, this aspect seemed much more crucial and tangible than the remote threat of Brexit. In addition, in terms of EU competition laws, the case is technically hard to settle since LSE and Deutsche Börse tend to focus on different market segments.
More importantly however, the European Commission is increasingly threatened and deprived of its key prerogatives. Jean-Claude Juncker, whose skills fail to impress European capitals and whose “sacking” is being considered in Berlin, cannot afford to voice his concern if German interests are clearly at stake. This deal would be both a financial and a highly political one, in an inter-state fashion. The final outcome will speak volumes about the state of mind surrounding the negotiations on the UK’s participation in the single market. Despite tailored public statements, the negotiations on the terms of Brexit have undoubtedly started, in a down-to-Earth manner and under the threat of a financial crisis not only in the United Kingdom, but also in the eurozone.