Deutsche Börse/NYSE Euronext ‘Merger Rationale’, Success Questioned – B.I.S.S. Research

London - 12 April 2011

‘Vertical Silo’ Model and IT Standardisation Stumbling Blocks; More Exchange Mergers Expected.

Deutsche Börse’s proposed deal to acquire NYSE Euronext is likely to face greater hurdles in passing both regulatory objections and prove potentially a more arduous task from a technological standpoint than the London Stock Exchange’s (LSE) tie-up with Canada’s TMX Group Inc., contends B.I.S.S. Research, a UK-based research firm offering global Accreditation of Systems and Services across the financial services sector.

Gary Wright, CEO and founder, B.I.S.S. Research, commenting in the wake of the $11.3bn counterbid from NASDAQ and InterContinental Exchange (ICE) for NYSE Euronext, says: “Integrating a fully-fledged merger between Deutsche Börse and NYSE Euronext in terms of IT operations and standardisation is a far more complex process than would be the case say with an LSE/TMX merger, which could be viewed as slightly easier technically to pull off.”

On Deutsche Börse’s settlement capability and positioning, he says: “They have a very tight vertical silo market capability in Germany, which does not really lend itself to the more horizontal or open market model espoused by Euronext in Europe and to a lesser extent at the New York Stock Exchange (NYSE) in the U.S. market place.”

Wright points also to “less overlap” in the LSE/TMX deal. TMX has already stated that they are interested in the LSE’s Millennium IT platform. On top of this, TMX’s Sola trading platform is anticipated to be deployed by the LSE for derivatives trading capabilities.

Technology standardisation between the leading clutch of European and North American exchange operators is clearly fraught with a number of issues, as well as regulatory and cultural hurdles. On the latter aspect, Wright observes that the Frankfurt exchange has in recent years almost “operated in their own way” vis-à-vis how the rest of the exchange world has behaved.

On clearing and settlement issues, Wright says: “Just how does one rationalise the respective ICSDs of Euroclear and Clearstream, itself a Deutsche Börse unit, with the Depository Trust & Clearing Corporation (DTCC) in the U.S.? The back-end processing aspects are quite complex to square technically as well as politically.”

He adds: “Having unveiled this Deutsche Börse/NYSE Euronext mega exchange merger deal, one could view it as a terrific deal in one sense. Yet one should be asking how these exchanges are going to effect the merger and over what time horizon?” The same might broadly be said over NASDAQ/ICE’s counterbid, which stands $1.1bn/10.78% higher than Deutsche Börse’s $10.2bn of this February.

The jury certainly is out, especially with European Commissioner for Competition, Joaquin Almunia having expressed doubts over the “vertical silo model” to a recent European Parliament hearing in late March.

B.I.S.S. Research’s City Analyst Roger Aitken says: “While the vertical silo model as operated by some exchanges has clearly proved good for the exchange business model in terms of revenues where it is operated, as customers are effectively tied into using a venue’s execution facilities with their associated clearing and settlement, the horizontal model where these operations are separated out, benefits customers through greater choice.”

Commenting on the evolution of exchanges in the current environment, Aitken makes the analogy of airlines building regional hubs to exploit sales channels to sell products and services. “The real issues for me in the listed exchange world centres on how exchanges like Deutsche Börse and NYSE Euronext tidy up their respective clearing and settlement sides,” he argues. “Effectively one has to make those into hubs as well.”

B.I.S.S. CEO Wright thinks that there is likely to be “more acquiring and many more deals” on the horizon in the exchange sector. “It’s not even half way there yet,” he contends. As to the touted $400m (c.€300m) cost savings from the Deutsche Börse /NYSE Euronext tie-up, the B.I.S.S. Research CEO sees some “real pruning” likely across the board.

“This is not going to be achieved by simply shutting down a few departments,” he says. “It will require wholesale changes to systems and fundamentally lopping off major parts from the combined operations.”

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