Why CME Group And Deutsche Bourse Merger Talks Make Strategic Sense

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Quick Take

     

  • CME Group is reported to have contacted Deutsche Bourse to open merger talks
  • Both parties have revealed no details on the development, and discussions are reported to have discontinued
  • The merger of the two entities makes strategic sense for CME Group as its major competitor, the IntercontinentalExchange, is acquiring NYSE Euronext
  • We believe the discussions could resume over time as both parties assess their strategic options

CME Group (NYSE:CME) is reported to have approached Deutsche Bourse for merger discussions towards the end of last year, according to a recent Bloomberg report. [1] While Deutsche Bourse strictly denied any talks with the American derivatives markets behemoth, CME has chosen to remain silent on this issue. Reports suggest that the talks did not progress due to Deutsche Bourse’s hesitation in undertaking a major M&A initiative after the NYSE Euronext-Deutsche bourse disappointment last year.

We mentioned in a recent article titled “A Closer Look At M&A Among Exchanges” that exchanges will likely continue to shop around for M&A deals as both buyers and sellers, and this week’s events provide more support to our analysis. We also said in the same article that the involvement of any major exchange in a deal is likely to push others into similar discussions as they try to protect their market shares. We believe that the discussions could reignite among the two firms as the bad taste from the failed attempts to acquire NYSE Euronext (NYSE:NYX) fades away in the memory of Deutsche Bourse leaders.

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Why is this happening?

Every exchange operator wants a piece of the OTC derivatives market that is set to grow significantly over the next few years. The regulations mandating central clearing of OTC derivatives are set to be implemented around the globe by mid-year and will bring previously unreported trading activity to central clearing firms – mostly operated by large exchanges.

While CME Group is capitalizing on this trend – having opened an OTC derivatives clearing arm in Europe in 2011 – its main competitor, IntercontinentalExchange (NYSE: ICE), is likely to take a big stride forward by integrating NYSE LIFFE operations if the ICE-NYSE Euronext deal is successful.

In Europe, NYSE LIFFE (a subsidiary of NYSE Euronext) and Eurex (a subsidiary of Deutsche Bourse) together control the majority of interest rate derivatives, a major class of derivatives. It was because of their combined control over the derivatives market that the European regulators did not allow the NYSE Euronext-Deutsche Bourse merger to succeed and with the strength of LIFFE operations on its side, ICE might have a chance to take market share in the derivatives marketplace away from CME Group.

It seems natural for CME to hunt for alternatives in this setting and Deutsche Bourse, which is the only real challenger to NYSE LIFFE, looks like the obvious partner.

What to expect?

Despite Deutsche Bourse’s stern denial, we believe merger talks between the two firms could resume in the future. ICE’s acquisition of NYSE Euronext creates some natural synergies for the combined entity in the interest rate derivatives market, and this will likely force Deutsche Bourse and CME Group to reconsider their strategies.

Anti-trust concerns will remain the biggest roadblock if such a deal were to happen. However, their merger is more likely to be palatable to the European anti-trust regulators than the Deutsche Bourse and NYSE Euronext deal.

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Notes:
  1. CME Said to Approach Deutsche Boerse to Weigh Deal Talks, Bloomberg, February 25, 2013 []