25 June 2007

LSE-Borsa Italiana tie-up may raise post-trade concerns

The merger of the London Stock Exchange with Borsa Italiana announced at the weekend could raise concerns over post-trading services if the vertically integrated Italian exchange chooses to roll-out clearing services for its London partner.

The merger of the London Stock Exchange with Borsa Italiana announced at the weekend could raise concerns over post-trading services if the vertically integrated Italian exchange chooses to roll-out clearing services for its London partner.

The London-Milan deal, worth just under 6 billion euros, sees the integration of two essentially different beasts: the horizontal, global player LSE and the vertically-integrated domestic monopoly Borsa Italiana.

Historically, the LSE has shied away from providing post-trade services – clearing and settlement – while, in contrast, Borsa Italiana's post-trade arm is heralded as Europe's most efficient. A reference in the merger's joint-communique to “the extension of post-trade services” has prompted fears that rolling out these services in the UK risks attracting the attention of competition authorities.

Top brass from the two exchanges speak of “significant opportunities” for Borsa Italiana's post-trading arm, believing they will be “very attractive to a number of major players and investment banks”. But they have also dodged questions as to how or whether post-trade services would actually be offered to LSE.

This debate raises the spectre of Deutsche Boerse's bid to buy the London exchange which the Office of Fair Trading refered to the Competition Commission. Further analysis duly unearthed worries over imparing competition in post-trading.

While Deutsche Boerse abandoned its bid, Euronext – which was also in the race – considered divesting its stake in LCH.Clearnet (the body LSE uses for its clearing and settlement services) in order to push a possible deal through.

The LSE has said in the past that – as a horizontal firm – it has no interest in post-trade services but now, as part of its deal with the Milan exchange, it is boasting about the efficiency of just such a business.

Competition concerns have lead some analysts to question the degree to which the merged entity will be able to roll-out post-trade services in the UK. One analyst claimed that the low level of synergies predicted for the merger may hint that the exchanges are shying away from a degree of integration which could raise regulators' suspicions.

Others suggest that the Borsa Italiana will just offer its cheaper post-trade services alongside LCH.Clearnet in free competition.

DG Competition had previously railed against Borsa Italiana's model of vertical integration, believing that the way to greater market efficiency was to break up such 'silos' and open up domestic markets to foreign competition.

This tactic backfired slightly. While a DG Competition study succeeded in exposing Deutsche Boerse as an expensive and inefficient vertical silo, statistics showed that one of Europe's other silos – the Borsa Italiana – had some of the lowest trading costs in Europe.

Borsa Italiana vigorously claims it is not a vertical silo but that its different clearing and settlement arms function as independent services with full interoperability. In its documentation for the merger it quotes the DG Comp study which shows that it has the cheapest post-trading services in Europe. Consequently, this is suggested to be one of the main advantages the Italian exchange brings to the merger.

Indeed, LSE and Borsa Italiana may be expected to argue to competition authorities that any integration of their clearing and settlement business will lead to greater efficiencies – as evidenced in the DG Comp paper – rather than a significant lessening of competition.

Representatives of LSE and Borsa Italiana are playing down the scaremongering, claiming that a lot has changed in the last few years; and with the new 'Code of Conduct' introduced by the European Commission to further competition and interoperability among Europe's exchanges “the world has moved on”.

The parties have led preliminary discussions with the UK's Financial Services Authority as well as the Italian counterpart Consob. Due to its size, the merger will require the approval of the LSE's shareholders at an extraordinary general meeting to be convened in mid-August this year.

By Lewis Crofts

© MLex