Cablegate: "King Maker" Deal for Europe's Stock Exchanges:
This record is a partial extract of the original cable. The full text of the original cable is not available.
UNCLAS SECTION 01 OF 04 FRANKFURT 010640
STATE FOR EUR PDAS, EB, EUR/AGS, AND EUR/ERA
STATE PASS FEDERAL RESERVE BOARD
STATE PASS NSC
TREASURY ALSO FOR IMB, Monroe ICN COX, HULL
E.O. 12958: N/A
TAGS: ECON EFIN EUN
SUBJECT: "King Maker" Deal For Europe's Stock Exchanges:
Lead or Leave
This cable is sensitive but unclassified. Not/not for
1. (SBU) Summary: The German Stock Exchange's (Deutsche
Brse (DB)) informal approach to purchase the London Stock
Exchange (LSE) has unleashed the next and biggest round of
consolidation in Europe's capital market infrastructure.
Euronext, DB's continental rival, reportedly has made its
own proposal. Bringing together two of Europe's three
largest exchanges would be a "King Maker" of a deal.
2. Although previous overtures to buy the LSE had been
rebuffed, now that the LSE is a publicly traded company,
purchase of its shares is more a question of price than
sentiment. DB's "hefty" price at a fifty percent premium
for LSE shares and apparent sensitivity not to alter LSE's
trading structure seems aimed to win pocketbooks as well as
hearts and minds. DB's self-proclaimed strategic imperative
is to be a global player and to either "lead or leave." The
outcome of its bid will reveal which it will be for DB.
3. Consolidation of share trading would have significant
implications for integrating European securities markets.
Through the EU Financial Service Action Plan, there is now
one EU-wide standard for trading rules, prospectuses,
reporting and auditing obligations. Overcoming barriers to
securities trading, clearing and settlement infrastructure
through a market-driven process would mark another major
step toward unifying EU securities markets. End Summary.
DB Renews its Proposal for LSE: Courtship before the Bid
4. (SBU) On December 13, DB confirmed that it had made a
proposal to the LSE Board with a view to making a cash offer
for the acquisition of all LSE shares. The LSE rejected the
proposal but agreed to engage in talks with DB to "ascertain
whether a significantly improved proposal" can be agreed.
This launches the next major, and possibly the most
significant, round of consolidation in European securities
5. (SBU) DB officials report that the private talks began
on the December 15th. Since DB has not made a formal offer,
no official process has begun under UK takeover law to
accept or reject the offer within a time certain (within 28
days of a formal offer, 60 days if only one offer is
submitted, the clock is suspended in the event competition
authorities decide to review the transaction). In its press
statement DB cautiously declares that there can be no
assurance that any offer will be made. According to one DB
official, results are not expected from the private talks
until early in the New Year. He did seem confident that LSE
could not afford to ignore the DB overture.
What Makes This Time Different: Being Public and Being
6. (SBU) Four years ago DB launched an unsuccessful bid to
merge with the LSE. Why should DB be confident of success
this time? One of the biggest differences is that both
firms are now publicly traded. In this particular case it
means the financially stronger can buy controlling interest
in the financially weaker firm on the open market. At the
end of 2003 DB's market capitalization was around euro 4.9
billion while, judging from DB's bid, LSE's was about euro
2.2 billion in mid-2004.
7. (SBU) One factor in LSE's rejection of the DB bid four
years ago was the large portion of local stockbrokers
holding interests in the LSE who were loath to see their
exchange sold. Now LSE shares are predominately held by
large institutional investors like Fidelity and Threadneedle
and even Deutsche Bank. These investors are more likely to
be driven by the bottom line than some of the emotion that
characterized the resistance to DB's efforts four years ago.
8. (SBU) One financial expert recalls the "ABW" feeling in
London at the time - "Anybody But Werner." This refers to
DB's CEO Werner Siefert who is has been described by the
local German press as "fresh-thinking, power hungry and
visionary." His brashness and aggressiveness is not
everyone's cup of tea. In the view of one London financial
expert, Siefert learned from the past and has launched a
"charm offensive" this time around.
9. (SBU) In appealing to these institutional investors'
bottom line instincts, DB was not shy in its proposal,
characterized by one analyst as "hefty." DB indicated an
offer of 530 pence per LSE share, a 52 percent premium to
the closing share price as October 22 and a 49.6 percent
premium to the average LSE share price in the last three
months. The proposal amounts to 2.6 billion dollars. LSE
shares increased 20 percent on news of DB's proposal. "LSE
shareholders will find this hard to resist," was the
assessment of one DB official.
10. (SBU) Another factor at play this time is that DB is
not seeking a merger to create a new, joint entity, but a
takeover. Rather than recreate the LSE in DB's imagine, DB
appears to be taking a more sensitive approach. According
to a DB official, DB would respect the LSE's "trading and
supervisory environment." Nonetheless, DB states that it
aims to drive down trading costs on the LSE. According to
DB's annual report, an equity market transaction at DB
typically costs 10.2 basis points but 13.7 basis points at
the LSE. Basis points are hundredths of a cent - that add
up in huge daily and yearly trading volumes.
11. (SBU) What all this really means in practice is the
subject of talks between DB and LSE officials. Press
speculation suggests that this could mean that the LSE could
retain its contracts with its current clearing (London
Clearing House (LCH, now called LCH.Clearnet - see below)
and settlement (Crest Co.) agents rather than having its
equity trades funneled into a "vertical silo" of clearing
and settlement via DB's Clearstream. However, DB's official
statement mentions that it would honor "existing
agreements." LSE's contract with LCH.Clearnet is renewed on
an annual basis. Some London analysts think that the only
way DB can justify the premium it is offering for LSE shares
while also promising lower trading costs would be to channel
trades to DB's clearing and settlement organizations.
What This Proposal Is Not
12. (SBU) It would be inappropriate to view DB's proposal
as a stock exchange deal of bilateral interest between the
Germans and British. First, DB is not German. Since going
public its German strategic investors have sold most of
their interests. At present, only 41 percent of DB shares
are owned by German firms. Fifty percent are owned by UK
and US institutional investors - some of the same that hold
shares in the LSE.
13. (SBU) Second, DB is not primarily a stock exchange in a
generic sense. Rather DB regards itself as a "transaction
engine," in the words of its annual report. DB uses its
technology that can "trade and settle anything that can be
traded and settled at low variable costs." DB's computers
execute trades performed on the Vienna and Dublin stock
exchanges, for example.
14. (SBU) DB's business model is to use its high-tech
investments for several lines of business. DB has balanced
sales from equity trading and fixed income/derivative
business of Eurex, its joint venture with the Swiss. It
earns nearly as much trading services as it does in post-
trade clearing and settlement operations. And it earns
nearly as much on exchange trading as in over the counter
business. LSE, by contrast, is principally an equity
trading organization deriving nearly all its sales from
15. (SBU) What this amounts to is that DB may be flexible
in how the final deal is structured, what stays in
Frankfurt, what goes to London. Whether this would mean
moving DB's headquarters to London is a delicate question.
To date, Siefert has only indicated that if LSE generated 45
percent of DB's business, then 45 percent of its management
would be based in London.
16. (SBU) Euronext, the French inspired but legally Dutch-
based securities organization, has made its own bid for the
LSE, according to press reports. Euronext's equity trading
brings together the stock exchanges of Paris, Brussels,
Amsterdam, and Lisbon in one trading platform.
17. (SBU) While market analysts believe that DB can bring
more money to the table (DB might have euro one billion cash
available compared to an estimated euro 300 million for
Euronext), Euronext has been highly successful in
integrating itself into the London markets. In 2002
Euronext acquired LIFFE, London's derivative exchange, to
create Euronext.liffe that competes with DB's Eurex. In
2003 the LCH merged with Clearnet, Euronext's clearing
agent, to create LCH.Clearnet which is 41.5% owned by
Euronext. Finally, Euroclear, Euronext's associate for
settlement operations, has part ownership in Crest Co the
settlement organization for the LSE. So even if it loses LSE
to DB, Euronext's strong presence in the London market would
enable it to offer an alternative-trading venue for LSE
listed shares should traders not be happy with new DB
Comment: Broader Implications: European Consolidation and EC
18. (SBU) LSE integration in one form or another into
either DB or Euronext would mark a major step toward
integration of European securities markets. Joining the
efforts of two of the three largest European stock exchanges
would be a "King Maker Deal," in the words of one observer.
The major exchanges in Spain and Italy, the two principle
European exchanges that have not aligned themselves with
either DB or the LSE, might seriously consider a
relationship with the predominate European exchange.
Commented a DB official, "they are sitting on the fence,
waiting to see who wins."
19. (SBU) Integration of major European securities markets
would benefit European investors and traders by offering a
broader, deeper pool of buyers and sellers and potentially
seamless back office operations to process their orders.
Capital allocation should be more efficient, contributing to
investments with higher returns that could contribute to
stronger overall economic performance.
20. (SBU) Such a result is just what the European
Commission has been targeting in its Financial Services
Action Plan. Directives on trading execution, prospectuses,
reporting requirements, market abuse, accounting and
auditing have created the legal basis for EU-wide rules.
Integration of securities market infrastructure would be the
next major task. While the Commission has favored proposing
a directive on clearing and settlement to push that process
along, a market-driven solution would be a better outcome.
Competition authorities may give the deal a close look.
However, if the EU is to realize its objective of a fully
integrated capital market, competition considerations would
need to focus not on the takeover itself but on elements of
21. (SBU) One of those elements would be the contentious
notion of the "vertical" silo. Such a silo exists when an
investor makes a trade on an exchange and then is obliged to
use that exchange's clearing and settlement operations. DB
has such a "vertical silo," arguing that "straight through
processing" benefits investors by reducing all-in costs.
22. (SBU) The Commission, however, wants to make sure that
investors can pick and use their own clearing and settlement
operations. Commission competition authorities have had an
eye on DB's vertical model. DB, knowing this is the
Commission's objective, could quell concerns by announcing
it would permit such switching by investors, according to
London's perceived wisdom. Euronext also boasts potential
straight-through processing through its clearing agent
LCH.Clearnet and its settlement "associate" Euroclear.
Thus, a directive in this area might serve a public policy
23. (SBU) From Embassy London's perspective, there is also
another dimension to the proposed takeover talks that goes
beyond the technical benefits and costs. Some City
observers believe a DB purchase of the LSE would remove one
of London's last independent financial landmarks, thereby
weakening London's role as the leading financial center in
Europe, and it also could strengthen the hand of the pro-
euro enthusiasts in the UK.
24. (SBU) For DB, its takeover of the LSE would represent
six years of work to become Europe's predominate securities
organization. Failing this time around or winning the LSE
but paying a price too dear, could relegate DB to the number
two spot in Europe securities operations. DB's annual
report explains that exchanges, clearing and settlement
organizations need to operate on a global, not national
basis. DB's self-proclaimed strategic imperative is "lead
or leave." The outcome of this latest round of
consolidation will show which it will be for DB.
25. (U) This report coordinated with Embassies London and
Berlin and USEU.
26. (U) POC: James Wallar, Treasury Representative, e-mail
firstname.lastname@example.org; tel. 49-(69)-7535-2431, fax 49-(69)-