FOR the chief executives of Deutsche Boerse (DB) and NYSE Euronext, this week’s hobnobbing in Davos was strictly business. A $9.5 billion plan to unite the two exchanges was derailed in early December when European Commission staff revealed they were likely to advise blocking it on competition grounds. The exchanges are lobbying hard to persuade the 27 EU commissioners to ignore their staff and approve the deal. A decision is due to be made on February 1st.
On the face of it, investors should support the commission’s recommendation to stymie the deal. Its competition wing is mandated to stop mergers that are likely to raise prices, reduce quality or dull innovation. In this case the concern is that the exchanges’ derivatives businesses—DB’s Eurex and NYSE Euronext’s Liffe—would share over 95% of European trading for some assets. There may also be concerns that a merged exchange would be able to force investors to use its clearing facilities (for which it could ratchet up charges) once trades have been made.
But there are reasons to think that the deal could be beneficial to investors. Exchanges are platforms on which buyers and sellers can meet, so a lower number of exchanges, which increases the potential for buyer-seller matches, can be better than a fragmented system. In addition, making all trades on one exchange could lower investors’ costs. This is because some assets (gold and equities, say) tend to be negatively correlated, so risks offset each other somewhat. An investor wagering that both gold and equities will go up should need to provide less collateral if a single exchange is used. Economists advising the exchanges estimate investors could reduce collateral-posting by €3 billion ($3.9 billion), a likely annual cost saving of roughly €300m.
Nor would a merger necessarily mean increases in trading charges. The biggest investors are vital to the exchanges (the five largest NYSE clients make over 20% of total trades). These investors could move to non-European venues if charges rise, or they could set up their own platforms to deal with each other. And since costs of entry are not prohibitive, plenty of other established exchanges could be tempted into Europe if venues there started to look very profitable. The threats of switching or entry should keep prices to large investors competitive. And since regulators would take a dim view of any price discrimination, small investors should be protected from high charges, too.
If these are all decent points for the exchanges to make, other arguments are weaker. The exchanges suggest regulation will be easier post-merger, so the deal supports financial stability. This is disingenuous. Regulators are wary of mammoth institutions that are too big to handle. And in a crisis some diversity in the system tends to enhance stability.
Nor should investors be particularly impressed by the DB-NYSE argument that Europe must have a unified exchange to compete with large or quickly growing exchanges in Chicago, Hong Kong and Brazil. The idea that competition law should be overridden by industrial policy to create a local champion that exploits economies of scale has often been used in merger cases. But the evidence does not support it: increasing size does not always make a more efficient firm, and governments have a mixed record when it comes to picking winners. The commission should allow the merger only if the benefits for investors stack up, not because Frankfurt is jealous of Chicago.