After enduring almost a month of triumphalism from the UK about how a merger of the London Stock Exchange Group and Deutsche Börse would bring great gains for the City of London, German politicians are making clear their response – “Not at the expense of Frankfurt”.
It is not that the Germans oppose the deal. They know that as competition intensifies between global exchange giants, Deutsche Börse must adapt to survive, and a merger with LSE Group would be a welcome addition to its strength. But they do not accept that the deal should be done at any price.
The two sides are so far apart on certain issues that the deal could lead to an open political clash between Europe’s two biggest financial centres.
The Germans are particularly irked that the LSE Group apparently made it a condition of the deal that the holding company, the legal entity owning the new, merged exchange group, must be incorporated in London. The Germans want it in Frankfurt.
Likewise, they argue that if the merged company runs a single clearing house, that operation should be in Frankfurt.
These demands are partly driven by a desire that Frankfurt should not be disadvantaged by the merger – if that looks likely, the finance ministry of Hesse, the region that includes Frankfurt, has said it would veto the deal.
But they also come from worries about the UK’s relations with the European Union. If you put the clearing house and holding company in London, the Germans say, it is hard to see the virtue of a European clearing house that is outside the eurozone and a holding company that could soon be outside the EU.
Members of different political parties even argue that the merger talks should be suspended until after the UK’s EU membership has been resolved by the referendum in June.
The two exchanges said March 16 that they were planning “a merger of equals”, with a “balanced governance structure” in which both companies were equally represented, and dual headquarters in London and Frankfurt – but one holding company, in London.
Clemens Reif, a member of the Hesse parliament for the conservative Christian Democratic Union, said it was important that the holding company should be incorporated in Frankfurt, within the eurozone and close to the European Central Bank and other regulators.
“We are convinced that this financial centre needs to be in Germany, especially because Britain is in the middle of a heated discussion about their European Union membership that will likely end in a Brexit,” Reif said. “In this case, London would be the wrong place for a head office.”
Although the plan is for the merged group’s first chief executive to be a German, Carsten Kengeter, the boss of Deutsche Börse, Reif said that German politicians and the German financial services industry should defend the interests of Frankfurt.
“We cannot simply give in,” he added. “The first chief executive officer would be a German, yes, but his successor could be American or British, and then we would be even more cut off.”
Florian Rentsch, a member of the Hesse parliament for the pro-business Free Democratic Party, said that the new holding company should be at the location of the stronger of the two stock exchanges, adding that the market capitalisation of Deutsche Börse was far larger than that of the London Stock Exchange.
“There are many arguments for the holding company to be at the company that is worth more, which is Deutsche Börse,” Rentsch said. “In addition, there is no risk that Frankfurt will leave the European Union.”
There was also resistance from Thorsten Schäfer-Gümbel, deputy chairman of the centre-left Social Democratic Party in Germany, and chairman of his party’s parliamentary group in the state parliament of Hesse, who agreed that it was crucial that Frankfurt did not lose out on this deal.
“We need to strengthen Frankfurt, and the holding should therefore not be in London,” he added. “Having successfully located the European Central Bank in Frankfurt and developed the renminbi-hub here, we do not want to take a step back.”
Schäfer-Gümbel and Rentsch both said that given the possibility of Brexit, the companies should suspend merger talks until there was more certainty about Britain’s membership of the EU.
Willi van Ooyen, a member of the Hesse parliament for the Left Party, who said he was “extremely critical” of the deal, added that under the currently proposed deal, jobs and income from taxes would be lost in Frankfurt.
Politicians in Hesse are still haunted by memories of the takeover of Hoechst, a local stalwart of the chemical industry founded near Frankfurt in 1863. It was bought by a French competitor Aventis, its legal incorporation moved to France, and after another French takeover, by Sanofi, little semblance of Hessian identity or influence remained.
Rentsch said Hoechst was the prime example that illustrated how a company’s interests shift to where the holding company is managed and regulated.
“We are in favour of strengthening Frankfurt as a financial centre, and the location of the holding company is a crucial factor,” Rentsch said, adding that it would be difficult to convince the Hesse finance ministry that it would be in the interests of Frankfurt to have this outside Germany.
The Deutsche Börse deal would have to be approved by the Ministry of Economics, Energy, Transport and Regional Development in Hesse, the Federal Financial Supervisory Authority in Frankfurt and the Financial Conduct Authority in London as well as the European Commission.
The regulators declined to comment for this article.
Zacharias Sautner, a professor of finance and head of the finance department at the prestigious Frankfurt School of Finance and Management, which has been asked by the Hesse finance ministry to advise on the deal, said the early imposition of conditions by London caused concern in Frankfurt.
“It is troubling that London has already said that the holding company would have to be in London and that its interests would have to be defended,” Sautner said.
“Hopefully, Frankfurt will do all it can do to have the central clearing house based here,” Sautner said.
Sautner said many transactions were being cleared through such central clearing houses, entities that sit in the middle of financial transactions. This system was introduced after the financial crisis to reduce counter-party risk between banks by ensuring that one side gets paid if the other fails.
“This is a topic the European Central Bank has also expressed concerns about: what will happen if this central platform, which has systemic importance for finance, has a problem? If it is in London, and there was a Brexit, it would be extremely difficult for the European Central Bank to act and ensure that this central clearing house could survive.”
The European Central Bank declined to comment on the topic, but in March 2015 lost a court case against the Bank of England in which it had argued that if clearing houses were managing trades in euros, they should be based within the euro area.
In 2011, politicians in Hesse opposed a merger between Deutsche Börse and the New York Stock Exchange.
“In the end, the European Union made its decision, but in any case we would not have agreed to the merger,” Reif added. Just over a decade earlier, a merger with the London Stock Exchange also failed.
Still, there appears to be a genuine will in Frankfurt for the deal to happen.
Sautner said without a deal, there would be a risk that Deutsche Börse would lose importance as rivals Intercontinental Exchange in New York, the Chicago Mercantile Exchange and the Hong Kong Stock Exchange grew.
“It is important that Europe has a strong stock exchange,” he said, adding that there could be considerable synergies between the LSE Group and Deutsche Börse.
These comments were echoed by Reif and Rentsch, as well as other senior politicians in Hesse. Reif said that the merger offered Deutsche Börse more opportunity than risk, and that both Frankfurt and London would need to evolve to compete with rivals in the US and Asia.
Kengeter said that Deutsche Börse, which had been under pressure to expand, would benefit from the deal because it would halt its decline in market share.
“The business that we are in is a fixed-cost scale business by virtue of the technology that is employed, he said. “It is also scale and fixed cost-related by virtue of the concept of addressing either liquid trading pools or clearing pools of superior size.”
Additional reporting by James Rundle
UPDATE: This story was updated on March 16 to include the views of Willi van Ooyen