Closed For Stock-taking: European Commission’s Prohibition Decision In Deutsche Börse/ NYSE Euronext
24 February 2012
On 1 February, the European Commission (“Commission”) announced that it had decided to prohibit the proposed merger between Deutsche Börse (“DB”) and NYSE Euronext (“NYSE”).
Commission merger prohibition decisions are particularly rare. There have been a total of 21 prohibition decisions since the EU Merger Regulation first entered into force on 21 September 1990. The two most recent prohibition decisions concerned the proposed Ryanair/Aer Lingus and Olympic/Aegean mergers. However, as the statistic indicates, the risk of outright prohibition should be seen as extremely marginal when weighed against the total number of cases (in excess of 4,500) reviewed by the Commission.
Relevant market and the position of the parties
DB and NYSE operate the two largest exchanges for European financial derivatives in the world: Eurex and LIFFE. The Commission opined that the proposed merger would have resulted in a quasi-monopoly in European financial derivatives, where, in the Commission’s view, DB and NYSE together control more than 90 per cent of the global market.
Derivatives are financial contracts traded on financial markets used to transfer risk and whose value is derived from an underlying variable or asset, such as stocks, interest rates or currencies. They are typically used for investment purposes, hedging and overall risk management in the financial markets. They can be traded on exchanges or over-the-counter (“OTC”).
The Commission’s market investigation assessed the extent to which customers of European financial derivatives switch between exchange-traded and OTC derivatives. The evidence collated by the Commission, including the parties' own documents, showed that exchange traded and OTC derivatives had different characteristics and fulfilled different customer demands.
Exchange traded derivatives are highly liquid, are traded in relatively small sizes (approximately €100,000 per trade) and use fully-standardised contracts. OTC derivatives typically concern much bigger transactions (approximately €200 million per trade) that allow full customisation of their legal and economic terms and conditions, tailored to the customer’s requirements. When a contract is available on exchange, derivatives users generally prefer this execution as it is much cheaper than OTC.
The Commission also pointed to a White Paper published by DB in 2008, which suggested that trading the same contract OTC is up to eight times more expensive. In the Commission’s view, this is why derivatives users would not switch from exchange traded to OTC if the merged entity were to increase trading fees. Further, there is an ever growing category of customers for which an exchange is the only option as, for various reasons, they cannot and would not trade OTC.
Barriers to entry and competitive constraints
The Commission considered that due to the "closed vertical silo" operated by LIFFE and Eurex (where the exchange's trading is exclusively linked to a clearing house), there were major barriers to entry.
As regards the degree of actual or potential competition from other exchanges, the Commission considered it unlikely that the Chicago Mercantile Exchange (“CME”) would become a credible competitive force in the area. It opined that CME would face considerable obstacles as, owing to its very different product portfolio, it would not be in a position to offer collateral savings comparable to those offered by the parties individually or the merged entity in the product area concerned. The Commission concluded that there was no prospect for CME, or any other new player, to exercise a meaningful competitive constraint on the two companies, DB/NYSE, in the products concerned in the foreseeable future.
Remedies to address competition concerns
Where a proposed merger raises more serious competition concerns, the parties’ typically offer remedies in order to address those concerns. Such remedies may be structural (e.g. a divestment) or behavioural in nature.
The parties offered a remedy package that consisted of three parts:
•a divestment of a part of LIFFE's European single stock derivatives business;
•access to the merged entity's clearing house for a materially new interest rate, bond and equity index derivatives contracts; and
•a licence to Eurex's interest rate derivatives trading software.
However the Commission, based on its market testing, considered that this remedy package would be insufficient in scope, difficult to implement and unlikely to be effective in practice. Although it was never offered as a formal commitment, the Commission also took note of the parties' pledge not to increase prices, but considered that as the pledge concerned list prices, it would be ineffective in practice, as actual prices in the market are often based on rebates. In addition, any such behavioural commitment would be difficult to implement and monitor and its relevance therefore in the Commission’s view was limited.
European champion and International cooperation
The Commission appeared unconvinced by the “European champion” policy argument raised by the parties. Such an argument gains little traction within a competition analysis. In this case, the Commission stated that the creation of a European champion at the expense of entrenching a monopoly with market power would not be beneficial for the European economy or for European consumers.
Given that the proposed merger was cleared subject to conditions by the Antitrust Division of the US Department of Justice (“DoJ”), the Commissions’ decision will reignite the debate vis-à-vis consistency of assessment when global mergers are at stake. There appears to have been a degree of interaction between the Commission and the DoJ in the current case. However, it must be noted that the Commission and the DoJ looked at different markets and focussed on different issues. While the Commission was concerned about derivatives based on European underlyings, the DoJ saw some issues in the US cash equity markets, ultimately requiring DB to divest its interest in the Direct Edge stock exchange.
The Commission is seeking to move what it perceives to be opaque and risky OTC derivatives onto clearing houses and exchanges, while also ensuring access to clearing in order to guarantee an open derivatives market with many players. It is clear that the Commission considers its decision in this case to be consistent with its overarching regulatory objectives.
The decision once again highlights the importance of the parties’ documents within the assessment process - the Commission in this case relying on a DB document to support its decision.
The merger is the latest in a line of deals to crumble. For example, the proposed merger between the groups that control the London Stock Exchange and the Toronto Stock Exchange was abandoned last June, clearing the way for a fresh bid for the Toronto Stock Exchange by the Maple Acquisition Group, a consortium of Canadian banks and financial firms. The deal is still awaiting regulatory approval at the time of writing. Last April, Australian Treasurer Wayne Swan formally rejected the proposed tie-up between stock exchange operators ASX Ltd, and Singapore Exchange Ltd., stating that the decision was based on clear, unambiguous advice from the Foreign Investment Review Board that the takeover would be contrary to national interests.
To view this article as an ezine, please click here.
The content of this article is provided for information purposes only and does not constitute legal or other advice. Mason Hayes & Curran (www.mhc.ie) is a leading business law firm with offices in Dublin, London and New York. © Copyright Mason Hayes & Curran 2012. All rights reserved.