Post-Brexit questions loom over Europe

The post-Brexit environment is still quite hazy, but the politicians and regulators in the EU are trying to lay markers for future discussions and negotiations. There have been several comments that betray a fear of further demands for exits from  the EU by the politicians and citizens of other countries that have high levels of Euro-scepticism, such as the Netherlands, France and Greece. 
The French president recently stated that clearing for Euro-denominated securities would no longer happen in London and this "could serve as a lesson" to those who are questioning the need for the EU. Strong words indeed for a market that currently gets jittery at the drop of a hat. In a similar move, the president of the German financial regulator, BaFin, has  also expressed doubts on the possibility of the LSE-DB merger if the resultant entity is based in London. The exchanges themselves have mentioned their intention to go on inspite of the added complexity due to Brexit, but I am sure they are keeping an eye on the political headwinds that are developing around them.
On their part, the British politicians and regulators are trying to calm the markets down and lull them into believing that little has changed in the aftermath of Brexit. The desire to delay invoking Article 50 to officially confirm UK's demand for exit is an example of this strategy, although EU leaders are opposed to this move. The claim by the politicans who supported Leave that there would not be any major and immediate economic or financial change after the referendum is another attempt of this nature.
While both these parties would probably be interested in discussing the issues that have arisen behind closed doors, in public they have to make the right noises to ensure damage control. There is also anger and resentment in the EU at the UK's decision and this shows from time to time in some of the comments. The German Chancellor Angela Merkel has a very balanced attitude to Brexit, but she has also conceded that the UK cannot enjoy access to the EU single market the same way as it did earlier, something that was suggested by Boris Johnson. There is a genuine concern in the EU to prevent cherry-picking in this regard. 
The various questions that have arisen post-Brexit will take a while to be answered. But what is clear is that there is going to be a significant parting of ways and the separation is going to be less than amicable, at least in public. For capital market professionals, in this landscape the discussion ends up being about political rather than economic or financial issues, in spite of trying otherwise. The latter have to take a backseat at time like this and this might continue for the weeks and months to come.

To Brexit and beyond!

So the Brexit has finally happened. The equity, forex and bond markets are still reeling from the news, the volatility probably caused as much by the fact that Brexit was unexpected as of yesterday night in the UK as by the event itself.
While the overall impact will reveal itself over the next several years, in the next few months the capital markets would have to deal with issues such as the future of the LSE-DB merger. Does it make sense anymore, and if yes, how do the two parties proceed? One would expect that now there would be political pressure to ensure that trading and jobs do not move away from either London or Frankfurt. Keeping all stakeholders happy would be a more complicated affair, although it could still be done.
EU wide market infrastructure regulations such as T2S and MiFID II would also now be seen in a new light. London was seen as the financial capital of Europe. The EU would now have to proceed with these significant changes at a time when the UK is preparing to exit, and is weighing its options in terms of how best to deal with the rest of Europe. It could take a middle ground as Switzerland has taken, or position itself even further away with more legal and policy independence but less overlap with the European capital markets.
In an earlier blog that considered the possibility of Brexit, I stated that technologically this might be the best time for an event such as the Brexit. Technology is more advanced and we are better connected than ever before across nations and continents. However, undoubtedly there will still be significant impact from an economic, financial and demographic point of view. As always, there will be winners and losers. As a neutral, one hopes that the people in the UK are able to achieve the goals they had envisioned in making this decision.

Is exchange consolidation desirable for global markets?

The CEO of Deutsche Börse made some very interesting remarks at the recent IDX derivatives industry conference in London. He argued that the proposed merger between Deutsche Börse and LSE would aid the development of trading in global markets because it would unite and harmonize the European capital markets, which are more fragmented than those in the US and Asia according to him. However, in this author's view, the merger of two large global exchanges raises as many questions as it answers. While one can agree that there would be less fragmentation and more harmonization, the main issue is whether the European market has a high level of fragmentation when compared with its global counterparts. Due to the European Union, European capital markets are much less fragmented than the Asia-Pacific, Middle-East and Africa, and Latin America. There has been a great degree of harmonization over the years, driven both by common regulation and industry mergers & takeovers. It is difficult to argue that there is a pressing need for more integration at this point. Instead, the main argument for the merger of LSE and Deutsche Börse is the fact that it would create a larger exchange that would be able to take on the likes of CME, Nasdaq and some of the leading Asian exchanges more easily. The expected reduction in headcount would also make for a more efficient, streamlined, and competitive exchange. But there are concerns that remain from an antitrust point of view and it is quite likely the Deutsche Börse CEO was trying to assuage these when he spoke about the positive effect of such a merger on global markets. If the merger does go ahead with regulatory approval, the advantage for other leading exchanges would be the higher possibility of such mergers and takeovers being approved in the future as well, since these could well be expected in an industry that is undergoing heavy consolidation due to economic and technological factors.

Everyone wants the LSE

I cannot imagine that too many people are surprised that there are others who would like to own the London Stock Exchange (LSE); ICE has just confirmed and CME is said to be considering a bid. I do not even want to attempt to count, beyond the three times that Deutsche Boerse has attempted to acquire LSE, the numerous other bids and courtship talks that have arisen over the years. In each case, however, it was a case where the courtship failed to make it to vows. At the same time, any banker worth his/her salt will be making noise around the possibility of other bids, to maximize economic value of the deal. Furthermore, in the case of a freely available exchange (which is mostly not the case given national protection, and the historical pride associated with having a national exchange), they rarely remain single for long. In the regulatory and trading environment in which we live, there is tremendous operational scale in very large exchanges. The technology infrastructure and maintenance cost is high, and global regulation, generally favors a migration to exchange trading and central clearing. And, given the turmoil that blockchain might cause in the exchange and clearing landscape, it will require high levels of R&D budget. Additionally, the continued march toward multi-asset trading, across all asset classes is another factor in this steady drive toward global mega-exchanges. As we have seen the desire for more and more insight, analytics, TCA, and best-execution in equities, we have seen the same call, in FX, and now the clarion is sounding for fixed income. Exchanges with the breadth of product, depth of experience, and vision of a multi-asset future are best positioned to compete with the best product mix, clearing choices, and regulatory insight for their customers. A deal with LSE is not going to be easy as the competitive concerns will have sovereign and European regulators deeply concerned about the implications on equity trading and clearing dominance. Finally, on a European level the deal makes sense; the German and UK exchanges merging under the European flag. However, the UK is not so sure it wants to remain as part of Europe. The Brexit discussion might translate into strong national feelings of pride for the LSE.

Were the proposed LCH.Clearnet and LME takeovers inevitable?

The reform of the financial markets through legislation such as Dodd-Frank Act (DFA) in the US and MiFID II (Markets in Financial Instruments Directive) and EMIR (European Market Infrastructure Regulation) in Europe seems to be creating powerful forces for market infrastructure reorganization. The expected takeovers of LCH.Clearnet and LME are examples of this change. I believe that there is an underlying suspicion that both these organizations would have struggled to compete after the full implementation of the recommendations of DFA and EMIR . The possibility of LCH.Clearnet losing the LSE and NYSE Euronext business due to the creation of in-house CCPs by these exchanges was a cause of genuine concern. Similarly, in the very competitive exchange environment, the tendency for rising consolidation was making the position of LME precarious. From an economic point of view, the rise in consolidation means that a handful of exchange groups have become dominant. These include the Deutsche Boerse/ NYSE Euronext combine, Nasdaq OMX, LSE Group, CME and ICE. How healthy this trend is from a systemic point of view only time will tell, but market regulators must be wondering if all that ‘too big too fail’ talk was having any effect. If anything, exchanges are becoming bigger than ever before. Now we are going to add a lot of the OTC derivatives clearing business to that. It would be interesting to see what plans the regulators have in place to manage a default by one of these groups. One must not tempt fate, but it certainly would not be wise to be unprepared.