Insight - D.Boerse/NYSE deal undone by smart opponents

The plaque of the Deutsche Boerse AG is pictured at the entrance of the Frankfurt stock exchange February 1, 2012.

FRANKFURT (Reuters) - They planned to create the world's biggest stock and derivatives exchange. But the Deutsche Boerse-NYSE Euronext deal fell apart because its opponents fought a clever campaign and officials in Berlin and Brussels found the U.S. style abrasive.

The $7.4 billion agreement to combine the exchanges was blocked by EU Competition Commissioner Joaquin Almunia this week because it "would have led to a near-monopoly in European financial derivatives worldwide."

It was always going to be a hard sell.

It is an established fact that the pairing would have controlled more than 90 percent of European exchange traded derivatives through Boerse's Eurex and Euronext's Liffe and regulators had already torpedoed a wave of trans-continental exchange consolidation kicked off by Singapore Exchange (SGX) Ltd's failed attempt to buy Australian market operator ASX Ltd last year.

So what were NYSE Euronext and Deutsche Boerse thinking?

Well, the monopoly argument cuts both ways. The vast majority of derivatives, futures and options on underlying assets like oil and shares, change hands on an over the counter(OTC) basis, outside the exchanges. Bank for International Settlements (BIS) figures put outstanding OTC contracts worldwide at around $708 billion compared with just $26 billion on the exchanges, and the banks that dominate the OTC market stand to lose their own grip on the market if an exchange big enough to offer serious liquidity emerges.

According to conversations Reuters has held with senior executives and politicians, NYSE CEO Duncan Niederauer and Boerse boss Reto Francioni hoped these arguments stood for themselves. They bet regulators would like some of the market-opening promises they were making, and that politicians would get behind a deal that could create a "European champion," rescuing Deutsche Boerse from the crippling competition it must now face from startup exchanges.

"It seems they were convinced from the beginning that this industrial policy point of view should work. Instead of looking at competition arguments on the market definition or the segmentation," said a lawyer involved in giving feedback to Brussels-based regulators about the deal.

Deutsche Boerse was also pinning its hopes on a wider push to regulate derivatives by Michel Barnier, the European Commissioner for markets, and the moves by the group of 20 leading economies to regulate global derivatives trading.

In particular, executives hoped for backing if they offered to open up post-trade processing services to rival companies, long a demand of the European Commission.

"Our thinking was that the Commission will do you a favour if you help them further their objectives in some other way, so we offered to open up clearing," said a senior Deutsche Boerse manager who declined to be named.

Company bosses in Frankfurt and New York harboured hopes that even with Almunia against the deal, the 26 other European commissioners could be swayed, particularly if high level politicians from Berlin and Paris threw their weight behind it.

Key to Almunia's decision to exclude OTC derivatives from his definition of the derivatives market was the input invited from potential competitors -- the so-called market testing process. It was clear that banks would use this opportunity to defend their turf.

"While the participants may be many and are of course in competition with one another, they nevertheless remain united in the single ambition to see that standardized equity options continue to trade over the counter," TABB group analyst Will Rhode said. "To that end, a merged Eurex Liffe would introduce a competitive element that has the power to break the OTC stranglehold."

The London financial community made its opposition to the Eurex Liffe deal clear when the powerful Association for Financial Markets in Europe (AFME), a London-based lobby group representing investment banks, law firms and data companies took part in a formal consultation process launched by the European Commission. The AFME confirmed it had made its objections to the deal clear to the European Commission.

The AFME also attempted to strike up a dialogue with Deutsche Boerse, two people familiar with the matter told Reuters. Andreas Preuss, head of derivatives and deputy chief executive of Deutsche Boerse responded, but the dialogue did not lead to a meeting of the minds, a person familiar with the exchange said.

The big OTC derivative players were not taking any chances.

Just in case the deal did win clearance, they made inquiries with Zurich-based SIX Swiss Exchange, asking the stock and derivatives exchange operator to consider starting a rival derivatives business to DB NYSE, a person familiar with the talks said.

POLITICAL EXCHANGE

While the anti-deal lobby was winning the argument with the bureaucrats, the Swiss/American CEO double act was also failing to convince politicians of the merits of the deal.

They had reason to hope for something better.

Back in 2006, when Boerse boss Francioni first attempted to buy Euronext NV, politicians including the German finance minister at the time, Peer Steinbrueck, and French President Jacques Chirac threw their weight behind efforts to create a pan-European company. That deal too included the idea of combining the two derivatives bourses Eurex and Liffe.

By contrast, this time around, Chancellor Angela Merkel and French President Nicolas Sarkozy refrained from making public statements, even though executives in Frankfurt and New York had sought to get their backing to help overturn opposition in Brussels.

"Francioni's 'secret weapon' -- his traditionally strong ties to high level politicians -- failed to detonate or hit the intended target," a senior manager at Deutsche Boerse said.

The personalities of the chief executives also undermined support for the idea that a deal would create a European champion, said people who watched the lobbying efforts of Niederauer and Francioni.

UNEQUAL DOUBLE-ACT

When Francioni, a reticent, 56-year-old Swiss who likes fly fishing and had an office built for him at Boerse's open plan headquarters, and Niederauer, an assertive American investment banker, appeared in Brussels in October, Brussels regulators quickly realised who would eventually take charge.

Although Francioni made a statement at the start of the closed-door hearing to assess the deal, it became clear to the 100 or so people in attendance that Niederauer was the main protagonist, said a lawyer for one of the deal's opponents who was there.

"Niederauer was handling the answers and controlling who said what and when. He was speaking unscripted. This is unusual for CEOs as usually it is the lawyers who speak at hearings rather than the CEOs," he said, adding. "Niederauer treated it like a U.S. event, he talked too much."

Niederauer did not stick to protocol, brushed aside the specific questions put to him about the issues of market dominance and instead tried to sway regulators with a passionate monologue about the global nature of the derivatives market, a lawyer who sat less than five metres away from Niederauer during the hearings told Reuters.

Presentation of the deal in Germany might have been better.

"They just slammed it on the table and expected people to rubber stamp it," said a senior German regulatory source, who wished to remain anonymous.

Dieter Posch, Minister of Economics in Deutsche Boerse's home state of Hesse, has the power to veto a deal and to revoke Deutsche Boerse's operating license.

Posch first learned about the takeover from newswire reports on February 9 while opening an art exhibition held at the Pushkin museum in Moscow. Later he got in touch with Almunia's antitrust staff, according to two sources close to the ministry - a fact corroborated by two sources familiar with Deutsche Boerse's thinking. Brussels slowly realised the deal did not enjoy full backing in Germany, a factor that made it politically less controversial for Brussels to block it.

"Posch made it clear what his reservations were," a person close to the Hesse Ministry said.

And before unveiling the deal, Francioni had not told local politicians in Germany about plans to combine the stock exchanges in Frankfurt, Amsterdam, Brussels, Paris, Lisbon and New York, as well as the derivatives markets. Deutsche Boerse says it would have been against disclosure laws to divulge details of the transaction to anybody ahead of time.

Posch sought answers to his concerns at a meeting with Niederauer and Francioni when they visited the ministry's neo-baroque Jugendstil palace in Wiesbaden on November 14, 2011, but was left with doubts about whether Frankfurt would benefit as a financial centre.

The fact that Francioni had repeatedly given assurances about his belief in standalone growth, while attempting to complete at least two transformational deals, undermined trust in his commitment towards Frankfurt as a financial centre, a person familiar with the ministry's thinking said.

The fact that deputy chief executive Andreas Preuss lives in England is also viewed with scepticism in Germany.

NYSE's track record in the aftermath of its Euronext NV takeover in November 2006 also hardened Germans against the deal in Frankfurt, according to another person close to the ministry's thinking. The deal was originally marketed as a merger of equals, but New York-based managers eventually took de facto control over Euronext.

NOT SET IN STONE

Political support at home further eroded after filings made to the Securities and Exchange Commission showed that Francioni's assurances about maintaining Frankfurt's influence in a combined company were not as strong as they might be.

"Both parties need to profit equally in a merger," Posch said in February after a meeting with Deutsche Boerse's labour representatives on February 23, adding that a deal with NYSE Euronext deal should amount to "development and not a regression" for Frankfurt as a financial centre.

Although NYSE Euronext and Deutsche Boerse told Frankfurt regulators that the position of chairman -- Francioni's designated role in the new firm -- would be extremely powerful, regulatory filings showed this power was limited until 2016.

Among other longer-term plans, the number of directors -- excluding the CEO and chairman -- would have been cut from 15 to 10, and Deutsche Boerse's 'quota' of influence would be at risk.

The fact that a Netherlands-based holding company would have controlled Boerse in the event of a successful deal finally persuaded Posch to resist the deal.

(Reporting By Edward Taylor, Andreas Kroener, Foo Yunchee, Paritosh Bansal, Oliver Hirt, Gernot Heller, Luke Jeffs; Editing by Andrew Callus/Janet McBride)