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Brussels, 1 February 2012
Mergers: Commission prohibits proposed merger between Deutsche Börse AG and NYSE Euronext – frequently asked questions
What is the role/importance of derivatives for the European economy?
Derivatives are contracts traded on financial markets that are used to transfer risk. Derivatives are of key importance for the European economy. This is because they serve as insurance against price movements and reduce the volatility of companies' cash flows, which in turn results in more reliable forecasting, lower capital requirements, and higher capital productivity. Derivatives have in recent years developed into a main pillar of the international financial system and are an indispensable tool for risk management and investment purposes. Derivatives contribute to improve the operational, information, and allocation efficiency, thereby increasing the efficiency of financial markets. They help lower the cost of capital and enable firms to effectively invest and channel their resources, thereby making them an important driver of economic growth.
On what basis was it concluded that OTC and exchange traded derivatives are in separate markets?
The Commission conducted a far-reaching market investigation to assess the extent to which customers of derivatives based on European financial underlyings switch between derivatives traded on exchange and over the counter. The evidence collected, which also includes the Parties' own documents, showed that derivatives traded on-exchange and OTC derivatives are products with different characteristics and which fulfill different customer demands. Exchange-traded derivatives are fully standardised liquid products typically traded in small size (around Euro 100 000 per trade). In contrast, OTC derivatives allow for customisation of their legal and economic terms and conditions, their average trade size is much larger (around Euro 200 000 000 per trade) and by definition cannot be executed on exchange. When a contract is available on exchange, derivatives users generally prefer this execution as it is much cheaper than OTC. This is why derivatives users would not switch from exchange to OTC if the merged entity were to increase trading fees. Indeed, already today, trading the same contract OTC is substantially more expensive (up to eight times according to a White Paper published by Deutsche Börse in 20081). In addition, there is an ever growing category of customers for which an exchange is the only option as, for various reasons, they cannot and would not trade OTC. This concerns in particular customers that, for risk management reasons, have no mandate or operational set-up to trade OTC.
What does the Decision conclude about competition between European short-term and long-term interest rate derivatives?
While European short-term interest rate derivatives are based on European interbank lending rates and European long term interest rate derivatives on European government debt securities, the market investigation showed that the boundaries between the two are becoming blurred. In addition, whether they are in one market or two, Eurex and Liffe compete with each other both as actual and potential competitors. Eurex has been trying to compete with Liffe's Euribor contract while Liffe has been trying to rival Eurex's long-term derivatives business. This competition has resulted in fee cuts in the past and would be eliminated by the merger.
What is the geographic scope of the market?
Globally, Eurex and Liffe are by far the largest players offering trading in European financial derivatives. Except for them, there are only two other exchanges offering trading in these contracts: CME in Euribor and the Singapore Stock Exchange in derivatives based on Stoxx indices. None of these achieves significant volumes. Indeed, since it started offering trading in Euribor futures, CME achieved a volume of around 2000 contracts in comparison with close to 250 million traded by Liffe annually. Therefore, whether the market is global or European, the merger would lead to a near monopoly in this product area.
Did the Decision take into account competition from other exchanges active worldwide, including the Chicago Mercantile Exchange?
Yes. CME, while being a significant player worldwide, has very limited presence in derivatives based on European underlyings which are at the heart of this case. Indeed, its volumes in Euribor futures are by no means comparable to volumes achieved by Liffe or even Eurex.2 CME focuses on US interest rate and equity index futures, and commodity futures. It is therefore very unlikely that CME would become a credible competitive force in this area. This is because it would face considerable obstacles, as owing to its very different product portfolio, it could not offer collateral savings comparable to those offered by the parties individually or the merged entity in the product area concerned.
Isn't the Commission, by prohibiting this merger, unduly preventing the creation of a "European champion"?
The Commission is not against "champions" as long as these are not created through mergers eliminating the only rival. The creation of a "European champion" at the expense of entrenching a monopoly with market power would not be beneficial for the European economy or for European consumers.
On what basis did the Decision conclude that Eurex and Liffe are each other's closest competitors in the markets concerned?
Eurex and Liffe are of comparable size in terms of their membership base and portfolio of contracts they offer for trading and clearing, and they both focus on European financial derivatives, namely European interest rate and equity derivatives. As a result, users of these contracts, at any given moment, have a choice between these two platforms. At the same time, there is no other competitor who can come close to matching the Parties' offering and margin pool in these contracts. Eurex and Liffe exert a significant competitive constraint on each other both as concerns the contracts where they currently compete and the contracts where liquidity has settled on one of their platforms. Indeed, the mere threat to move business from Eurex to Liffe and vice-versa means that they constantly keep each other on their toes. This has resulted in fee cuts and prompted innovation in the past. The proposed merger would have removed this constraint, likely leading to higher fees and less innovation.
How did the Commission analyse the role that banks play in the market?
Banks are key participants in financial markets. Their role in the derivatives markets in question has been analysed in great detail. The market investigation showed that banks, in their interdealer broker role, principally focus on the OTC market. They are also customers of exchanges for exchange-traded derivatives.
How did the Commission assess the claimed collateral benefits of the proposed merger?
The Commission analysed in great detail the claimed benefits of the merger between Eurex and Liffe. The Commission's analysis showed that it is likely that the merger would lead to some collateral savings due to increased cross-margining opportunities. However, the level of these savings is significantly lower than the figure of Euro 3.1 billion initially claimed by the Parties (which is acknowledged by the Parties themselves), and is rather in the range of tens of millions of Euros. This is because it is not the collateral savings but the opportunity cost of holding cash or securities as collateral (i.e. the extra benefits that could be gained by using this money in the best alternative usage) that are the relevant measure of actual cost savings from lower collateral requirements. The Commission also found that some of the collateral benefits could be achieved by other means than the merger and that, in view of the market power of the merged entity, it could recoup a portion of any such savings, thereby reducing any actual benefit for customers. In any case, any such savings would be insufficient to outweigh the significant harm that would be generated by a merger to near monopoly.
How did the Commission assess the claimed liquidity benefits of the proposed merger?
The Commission analysed to what extent a merger between exchanges has the potential to increase liquidity. On the basis of a detailed analysis of various economic studies, the Commission concluded that there is no evidence that liquidity would be likely to increase as a direct consequence of the merger. Academic studies have shown that rather than consolidation, it is competition such as that observed in cash equity markets since the introduction of MIFID in 20073 which has the potential to generate significant liquidity benefits.
Why were the remedies proposed by the Parties considered insufficient to remove the competition concerns identified in this case?
The Commission took very seriously all remedy proposals and conducted two extensive market tests. The Parties offered a remedy that consisted in three parts: (1) a divestment of a part of Liffe's European single stock derivatives business, (2) access to the merged entity's clearing house for materially "new" interest rate, bond and equity index derivatives contracts, and (3) a licence to Eurex's interest rate derivatives trading software. The market test showed that overall, this remedy package would be insufficient in scope, difficult to implement and unlikely to be effective in practice.
As regards the divestment part of the remedy, there were question-marks about the viability of the proposal in light of the necessary regulatory approvals and the likelihood that customers would trade out of their positions rather than transferring them to a new acquirer. This would lead to the erosion of the transferrable open interest. In short, the divested assets could be too small and not diversified enough to be viable on a stand-alone basis.
As concerns the access remedy, the market test showed that besides a number of technical issues associated with such access, there were essentially no contracts that would meet the stringent eligibility criteria and for which there would be a customer demand. This remedy only applied to materially new products although such products are rare. Indeed, most innovations in the derivatives industry concern products that are developed around existing contracts. The Parties constrain each other today with regard to both existing products and adjacent innovations.
Finally, the licence commitment proved to be immaterial as other competitors in most cases already have such software.
As a result, no competitor showed credible interest in the commitments as a whole. It follows that the Commission was not in a position to accept these remedies as they would not restore the competition lost as a result of the merger.
Did the Commission take into account the Parties' public commitment not to increase prices for three years?
Although it was never offered as a formal commitment, the Commission took note of the Parties' pledge not to increase prices. In any event, the pledge concerned list prices and would be ineffective as in practice, actual prices are often based on rebates. In addition, any such behavioural commitment would be difficult to implement and monitor. Its relevance was therefore limited.
Did you co-operate with the US authorities?
As is our practice, the Commission and the US Department of Justice (DoJ) cooperated closely in this matter, although the issues on which we focused were different. Whereas we were concerned about derivatives based on European underlyings, DoJ saw some issues in the US cash equity markets.
Would the transaction not bring economy wide benefits, in particular improving the financing possibilities for SMEs?
The effects of the MIFID regulation on cash equity markets have shown that it is competition, and not consolidation leading to monopoly, that brings about benefits to the economy and users in terms of lower fees, better liquidity, higher quality services and more innovation. As regards SME financing, it is unlikely that the transaction would facilitate better access of SMEs to equity finance. Even if the transaction would have led to a wider investor base, this would not have a significant effect on SMEs given that SMEs mainly appeal to local investors. In any event, the Commission did not find competition concerns in the cash listing, trading and post-trading markets. Therefore, if the Parties had offered suitable commitments in the area of derivatives markets, the merger could have been cleared and any claimed benefits in cash markets safeguarded.
Did the Commission take the regulatory environment into account?
Exchanges already operate in a very regulated environment. In line with G20 Commitments, upcoming regulation is likely to result in greater volumes being cleared and traded on exchange. The shift of certain contracts from OTC to the exchange environment will enlarge the scope of exchange-traded derivatives for which Eurex and Liffe compete. Contracts that cannot be traded on exchange will still continue to be traded OTC.
Is this decision consistent with the Commission's own efforts in regulating the financial sector?
MIFID introduced competition in cash equity markets. In its ongoing regulatory efforts4, the Commission seeks to move some opaque and risky OTC derivatives onto clearing houses and exchanges, while also ensuring access to clearing in order to guarantee an open derivatives market with many players. This Decision is therefore fully consistent with the Commission's regulatory objectives.
Euribor is the reference three-month interbank lending rate for the euro zone.
Directive 2004/39/EC of the European Parliament and of the Council of 21 April 2004 on markets in financial instruments ("MiFID"), OJ L 145, 30.4.2004, p.1.
Regulation on OTC Derivatives, Central Clearing Counterparties and Trade Repositories (EMIR) aims at mandating CCP clearing of eligible OTC derivatives (COM(2010)484)); Regulation on Markets in Financial Instruments (MIFIR) provides for interoperability of CCPs and fungible access in the area of derivatives.