Take it to the limit.
Take it to the limit one more time.
- The Eagles
The action in the global Monopoly-like game being played by exchange management firms [CME Group (NASDAQ:CME), Intercontinental Exchange, Inc. (NYSE:ICE), London Stock Exchange (LSE), Deutsche Boerse (OTCPK:DBOEY), Nasdaq Inc. (NASDAQ:NDAQ) and CBOE Holdings (NASDAQ:CBOE)] shifted to Europe following Brexit. The issue of the moment is the sale by the LSE of LCH:Clearnet to Euronext. The resolution of the larger question, does London securities trading combine forces with Frankfurt securities trading, will impact the ultimate future of the entire European Union [EU]. But Brexit has made this combined trading a mistake for London.
The LCH deal: regulatory and economic perspective
The effect of Brexit on global commerce hangs in the balance. Will Continental Europe follow its instincts, taking a reactionary path, excluding the US and UK players; CME, ICE, Nasdaq and LSE? The answer appears to be "Yes." The first evidence of the EU's lack of openness to inter-market corporate combinations will come with the ultimate disposition of the components of the LSE. In the wake of Brexit, LSE and Deutsche Boerse have proposed to offload LSE's French subsidiary, LCH.Clearnet SA, to Euronext [ENX]. LSE is already in talks with Euronext to sell them LCH. This maneuver smacks of arm-twisting by the EU.
The apparent overriding objective of European negotiators in merging LSE and Deutsche Boerse is to prevent the encroachment of CME and ICE into Continental exchange ownership, on one hand; and to mollify the concerns of EU regulators, who see a single large continental European exchange as an anti-trust issue, on the other. Those objectives no longer work in London's favor, post-Brexit.
The economic realities do work in favor of the sale by LSE of LCH to Euronext, since both LCH and Euronext have significant OTC interest rate swap clearing operations and, with the decline of CME's interest rate swap clearing business, will be close to monopolizing that market when combined. So, the regulators will gain the appearance of a tough antitrust position, while the market will gain the reality of a monopoly.
Another plus for LSE in ridding itself of LCH is the nature of OTC clearing; a high risk, high cost, low value proposition.
The LSE-Deutsche Boerse deal: bigger picture
Brexit seriously weakens the logic of an LSE/Deutsche Boerse combination, from London's point of view.
The basic factor determining success of the financial sectors of the two European capitals, London and Frankfurt, long run, will be the locus of the greatest volume, by value, of securities traded in Europe. Also, will trading be in dollars, sterling or euros? Any calculation of the answer hinges on three questions:
- Will London open securities trading in dollars?
- Will London dominate trading volume?
- Will the euro survive?
From Frankfurt's point of view, the LSE/Deutsche Boerse transaction is a win-win. The euro survives and the balance of volume moves to the euro; Frankfurt wins big. Any other outcome, Frankfurt has spread its risk.
From London's point of view, the door to these pro-Frankfurt outcomes is opened by the deal. After Brexit, other than offloading LCH to Euronext, it is hard to see any advantage to LSE in the deal.
The possibility of dollar exchange trading was opened by Brexit. The Continent, and perhaps the US, would have none of that otherwise. Would London profit from opening exchange trading in dollars? The answer is an obvious "Yes." That way, London could double up on its coup of the 1970s, the opening of the trading of dollar-denominated deposits.
From the point of view of securities traders, the possibility of dollar securities trading in London is positively mouth-watering. Much as hostile US banking regulation drove dollar deposits to London in the 1970s, hostile SEC regulation has begun a slow leak of exchange trading to London.
The opening shot in this exodus was the recent announcement of a joint venture between CME and the Royal Mint, a branch of the British Treasury. The two intend to open a market for spot trading in gold. As I discuss here, this is a regulatory coup for the CME, which gains access to spot trading without confronting SEC regulation. Further movement of spot dollar-denominated exchange trading to London would put the same pressure on the SEC to reform its inefficient, expensive, National Market System that the flight of dollar deposits placed on US bank regulators to reform banking rules.
Implications of a successful Brexit upon the future of the EU
Brexit revealed that walls make more than a castle; they sometimes make a prison. For the nations in the shadow of the former Soviet Union, the European Union boundary was once a barrier to entry. Both the EU and the countries of the former Soviet Union welcomed the post-Soviet increase in membership. But, increasingly, countries of the original EU see the boundary as the walls of a prison.
A common currency seems, in principle, to be a sensible tool for promoting commerce and interaction among nations torn by war in the past. What were the original motives of individual countries?
- Perhaps the nations of the EU, other than Germany, saw the EU as a source of protection from German domination.
- Germany hesitated to join a common currency with more socialistic, less fiscally conservative, countries such as France and Italy.
As it happened, both national groups may have been mistaken. There is no doubt that Germany has taken advantage of the EU to expand its domination of Europe. No longer based on force of arms, Germany rules the EU through the economic weapon. It uses its economic strength to impose its will on the rest of the EU in other policy matters, such as immigration.
With the passage of time, the conflicting interests of other EU members have threatened the EU. Finally, with Brexit, Britain breached the EU wall, escaping. It is no stretch of the imagination to believe that a successful Brexit will lead to the demise of the euro, at a minimum, and perhaps to the demise of the European Union in its entirety. Departure of France and Italy from the EU is likely to appear on ballots in these countries' coming elections.
If the UK prospers from Brexit, the outcome is certain. The EU will go the way of the Soviet Union. The first step in achieving this British objective is to expand its dominance of European financial markets.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.