Executive Summary
This economic analysis shows that the merger between Deutsche Börse (DB) and the London Stock Exchange (LSE) will strengthen Frankfurt as a financial centre and that all major stakeholder groups for the exchanges – such as their shareholders, employees, regulatory bodies but also the two exchanges’ clients – will benefit from the merger.
Firstly, this is due to Brexit, which will make Frankfurt the clear European centre for financial market regulation and simultaneously, Frankfurt might indeed become the European centre for supranational risk management. By providing a broad-based financial market infrastructure, DB substantially contributes to transparency and hence to the stability of the financial markets − this applies in particular to its operation of Eurex Clearing, the integrated clearing service, as a central counterparty (CCP). The larger the share of financial transactions cleared internationally via Eurex Clearing and hence the more transparency there is regarding the risks to financial market stability, the easier their supervision and regulation will become. Without a merger, the European Central Bank (ECB) is in danger due to Brexit of losing the ability to supervise interest rate and currency transactions, which at present are largely cleared in London, since it would then have no authority over the most important market for its management instruments. A merger between DB and LSE can help counteract this and substantially increase the current quality of regulation.
Other important factors, which are leading to a radical change in the competitive environment, are the continuous process of digitisation, the rise of new competitors in the financial technology sector, the aggressive approach adopted by North American and Asian competitors and the shift in the weighting of global added value towards Asia. Over the past ten years, Frankfurt’s significance as a financial centre has declined and it has fallen from 6th place to 19th place in the Global Financial Centres Index. The resulting danger that Frankfurt will become less important can be countered by a merger with a strong partner.
A functioning capital market is particularly essential in view of the real economy’s increasing need to source finance – which entails a certain risk – for the digitisation process leading to Industry 4.0; the sum needed is put at EUR 40 billion per year in the period up to 2020. Since capital provision for middle market companies is considered inadequate throughout Europe, DB in particular offers a natural alternative for meeting the real economy’s financing needs. In order to maintain their position in the face of global competition, it makes sense for DB and LSE to take concerted action.
In addition, a merger between DB and LSE offers promising opportunities for Frankfurt’s currently weak primary market activities. Since banks now cannot adequately provide capital for middle market companies in particular, a way must be found for enterprises to raise finance on the capital market by issuing corporate bonds. In contrast to Frankfurt, LSE has extensive on-exchange bond trading activities featuring a large number of experienced investors. A merger between DB and LSE would open up the London market to middle market companies and would give them the opportunity to finance investments in Germany using debt. In the longer term, companies which are successfully listed on the debt market in London would also have much stronger prospects of going public in Frankfurt.
In addition to debt finance, the primary market offers ways of obtaining equity finance; in DB’s case, through the Deutsche Börse Venture Network and its new growth segment for SMEs, which specialises in early-stage financing for companies. However, the support structures here are far less developed than in London, which has a much more capital-intensive early finance scene. In addition, the number of investors here is still comparatively small, as is their risk appetite. This means that Frankfurt – although it presents itself as well positioned from a national and Continental European perspective as an investment location for venture capital and FinTechs – is lagging behind London in this area.
A merger between DB and LSE would make it easier for German companies, and FinTechs in particular, to access London’s venture capital industry offering access to the global market, hence facilitating growth and innovation and so encouraging a greater number of FinTech start-ups and IPOs in Frankfurt in the longer term.
Conversely, particularly after Brexit British FinTechs will find it more difficult to access the European Single Market and, in the wake of the merger between DB and LSE, forming a Frankfurt-based Continental European branch will seem the natural choice. This will result in employment, innovation and growth effects for Frankfurt.
On the secondary market too, companies that are already listed and securities service providers can both benefit from a merger between DB and LSE. Strengthening liquidity on the secondary market in Frankfurt and London will reduce companies’ risk and costs of capital. This seems particularly sensible for both financial centres in order to enable them to hold their own against the globally dominant exchanges in North America and Asia. The mergers between the stock exchanges in Amsterdam, Lisbon and Paris that produced Euronext can serve as a positive example here, since they led to substantial increases in liquidity, cost savings and improvements in efficiency, which were passed on to clients in the form of lower fees.
Since Frankfurt is already regarded as a key derivatives trading centre, a merger between DB and LSE also offers benefits in this area. Although hardly any on-exchange derivatives trading takes place on LSE, it has a large over-the-counter (OTC) market for interest rate and currency derivatives. A merger between Deutsche Börse and LSE can lead to structural change here if, in those cases in which there is sufficient market liquidity, contracts that are currently traded OTC can be developed into exchange traded derivatives, thus producing a shift towards regulated market trading.
The merger between DB and LSE produces a wide range of potential opportunities and positive network effects for Frankfurt as a financial centre. Without a merger between DB and LSE, the importance of the German exchange operator and their stakeholder groups, and hence of Frankfurt itself as a financial centre, will decrease substantially in the medium term.
