Deutsche Boerse/NYSE Mega-Merger More About Derivatives Than Stocks

The merger proposed yesterday (Tuesday) by Germany's Deutsche Boerse AG and NYSE Euronext Group (NYSE: NYX) will create the world's largest financial exchange. But most observers feel the deal is being driven more by the exploding market in derivatives and other exotic instruments than good old-fashioned stock trading.

While the $9.53 billion all-stock deal creates the world's largest trader of equities, it's the chance to exp
and the combined entity's presence in derivatives markets that held the real appeal, according to most observers.

Under the terms of the deal, Deutsche Boerse shareholders will control 60% of the new company, with NYSE shareholders owning 40%. One Deutsche Boerse share will be exchanged for one share of the new company's stock, while each share of NYSE Euronext will be swapped for 0.47 share of new company stock, The Wall Street Journal reported.


In a political nod to New York City's status as the world's most important financial hub, the company will have duel headquarters in Frankfurt and New York. NYSE Euronext Chief Executive Duncan Niederauer will be CEO of the new company, while Deutsche Boerse CEO Reto Francioni will be the chairman.

When the deal is completed, Deutsche Boerse will own a company that may generate more than 50% of its earnings from options and futures by 2013, Ed Ditmire, an analyst at Macquarie Group Ltd. in New York, told Bloomberg News.

Earnings from those instruments will top $462 million by 2013, based on analyst estimates compiled by Bloomberg.

The derivatives business of both firms would then be worth $24.7 billion by itself, 5.7% more than the market capitalizations of both companies combined before the two trading giants announced they were talking this week.

"The main reason that this deal occurred is that the market is moving towards the derivatives," Matt McCormick, a money manager at Cincinnati-based Bahl & Gaynor Inc., which oversees about $3.2 billion, told Bloomberg. "It's not because they want real estate on Wall Street."

Derivatives are a contract between two parties used to hedge risks or speculate. They can be based on an underlying asset such as stocks, bonds, currencies or commodities. They can also be linked to specific events like changes in interest rates.

Derivatives have become so valuable to trading venues because they can yield operating margins of as much as 55%. The merger will create the world's largest futures exchange accounting for 40% of the U.S. options market.

By bolstering their profile in the derivatives market, the companies are moving to offset revenue declines in stock trading. Derivatives revenue climbed 14% last year at NYSE Euronext, while cash equities fell 10%, as smaller trading platforms geared toward high-speed automated trading cut into volumes.

NYSE Euronext countered by investing heavily in technology and building data centers in Mahwah, New Jersey, and outside London where customers can house trading systems closer to the physical exchanges to speed transactions.

But fourth-quarter earnings still declined by 20% from 2009, NYSE Euronext reported last week. The company said slumping trading volumes in the United States and Europe and gains by the dollar against the euro hurt its bottom line.

The deal creates an unprecedented exchange powerhouse with more than $20 trillion in annual trading volume and operations in Germany, France, Britain, Amsterdam, Portugal, Belgium, and the United States, according to Reuters.

The companies said the takeover would yield cost reductions of $400 million (300 million euros) a year.

The deal follows a revival of merger activity in global financial exchanges after a period of quiet in the wake of the financial crisis.

International mergers between exchanges often raise hackles among politicians who see them as symbols of national pride and important means of raising capital and other business.

The London Stock Exchange's bid to take over Toronto Stock Exchange operator TMX Group Inc. (PINK: TMXGF) has fanned concerns about foreign ownership in Canada and regulators are sure to closely scrutinize the Deutsche Boerse - NYSE Euronext deal.

Just last week, the Singapore Exchange revised its $7.9 billion bid for Australia's ASX by increasing the number of Australians on the board of directors in an effort to win support from reluctant politicians.

After the deal closes, Deutsche Boerse's Eurex unit and NYSE Euronext's London-based Liffe unit would control more than 90% of European exchange-based futures trading, Reuters reported, raising antitrust questions among regulators.

In the United States, the Department of Justice and Securities and Exchange Commission will have final say on the merger.

Traders who use the exchanges have also expressed concern over the proposed deals, raising fears about a lack of competition.

"Euronext and Deutsche Boerse are still screwing us on fees for clearing, the closing auctions and small and mid-cap trading -- the areas where they still have virtual monopolies," the head of markets at a large European bank - who declined to be named - told Reuters. "A merger is concerning because together they will be more powerful and better placed to protect these monopolies."

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