Streetwise Professor

January 12, 2012

SWP: Carnac or Blind Hog?

Filed under: Economics,Exchanges,Politics,Regulation — The Professor @ 11:48 am

When the NYSE-Deutsche Boerse deal was first announced, I wrote:

The biggest uncertainty surrounding the deal involves European antitrust approval.  As noted above, the merging exchanges are not direct competitors in any major product.  In the US, in the mergers of CME and CBT and CME and NYMEX, that fact was decisive in avoiding  Justice Department challenges.  It should be in Europe too, but I’m not as familiar with European antitrust thinking or precedents so I’m not sure they’ll see it the same way.

The most interesting question involves clearing.  European policymakers have been critical of vertical integration in clearing.  (The USDOJ is too, but only disclosed its (economically nonsensical) objections after the CME-NYMEX merger closed.)  They deem vertical integration as anticompetitive, and have failed to consider seriously the efficiencies that integration can generate (a subject I’ve written a lot about on SWP and my academic research).

Given this skepticism, the Euro antitrust folks may view this merger as an opportunity to open up access to clearing at Deutsche Borse and LIFFE.  That is, I could see them conditioning approval of the merger on the parties’ agreement to open up access to their clearing services.  It will be interesting to see whether they attempt to do so: I estimate that there is a non-trivial probability of this happening.  If they try, it would likely be a deal killer.  DB in particular has been adamant that integration is an essential part of its model and strategy, and LIFFE has adopted that view as well.  A deal becomes much less attractive–and, in my opinion, unattractive–if it requires a fundamental transformation of the exchanges’ business models.

Well, that’s pretty much come to pass.  The European Commission has apparently decided to block the deal.  Initial reports state that the Commission believes that the combined EuronextLIFFE-Eurex derivatives businesses would have too much market power, based on defining the relevant market as European exchange traded derivatives (an indefensible definition, IMO).  But some informed opinion suggests that the real sticking point was the refusal of the exchanges to open up the derivatives clearinghouse.  This was one of the proposed remedies, and one which the exchanges rejected.

So it pretty much played out as I forecast.  The European regulators would demand an end to the vertical silo.  The exchanges would refuse.  The deal would die.   And that appears to be precisely where we are.  The deal is not formally dead, but it was coughing up blood last night (see about the 3 minute mark).

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