The heads of the London Stock Exchange Group and Deutsche Börse went to Brussels at the start of February on the verge of clearing a major obstacle for their historic €29bn merger.
Xavier Rolet and Carsten Kengeter thought EU regulators were set to bless the deal they had been working on for more than a year.
But midway through the meeting, Mr Kengeter stepped out to take an emergency phone call.
The 49-year-old German was informed that the Frankfurt public prosecutor had raided his office and home: he was under investigation for insider trading in the period before his company’s talks with the LSE were unveiled.
It was the latest in a series of shocks that conspired to undermine a deal that was meant to link Europe’s two most powerful financial capitals, London and Frankfurt.
In the frantic four weeks that followed that call, their dream to create a European markets champion with a pool of capital that would rival US and fast-emerging Asian competitors has all but died.
On Sunday, the UK group delivered what is likely to be the fatal blow. The LSE decided it would not meet an unexpected demand from Brussels that it dispose of its Italian bond trading platform called MTS. That meant it was unlikely that European regulators, led by EU antitrust commissioner Margrethe Vestager, would approve the deal as it stood.
1. Feb 23 2016: D Börse lines up swoop for LSE
2. Jun 24 2016: UK votes for Brexit
3. Jan 3 2017: LSE sells French clearing unit for €510m
4. Feb 7 D Börse and LSE offer concessions to Brussels
5. Feb 16 LSE and D Börse set to offer more concessions
6. Feb 27 LSE-D Börse merger crumbles as tensions boil over
The breakdown in trust between the two men, who orchestrated the deal before the UK voted to leave the EU, became more apparent this week.
Mr Kengeter, an ambitious former banker who was set to run the combined company, said he regretted the LSE’s stance: “It would be futile for me to speculate on what the reasons were for this decision.”
People close to Mr Rolet, a Frenchman who masterminded the re-invention of the LSE, said the executive was immensely disappointed and spread the blame widely, including on those who backed Brexit.
“This was all about cementing London’s role . . . He feels that the Brexiters have blown it up,” said one of these people.
The merger that would have been the biggest shake-up in the industry for more than decade is now hanging by a thread and is expected to be formally blocked in a month’s time. It was the third attempt to bring the two exchanges together after failures in 2000 and 2005.
From the outset, both knew it would be a tricky task to steer the merger through. The combined company would have become the world’s largest exchange by total income. It would be one of the biggest for equities listings and would control more derivatives trades than any other entity in the world.
When LSE and Deutsche Börse announced the merger last March, they chose London as the base for the combined entity’s holding company. They thought that reflected the City’s status and would balance the plan to install Mr Kengeter as chief executive. In truth Mr Kengeter always preferred London, where he lives with his family.
But after the UK’s referendum vote, the idea of the group being based outside the EU was too much for many German politicians and regulators, who called for a rethink.
Michael Fuchs, a politician from Angela Merkel’s ruling CDU party, backed the merger but said Frankfurt should host its headquarters. “Especially in view of the approaching Brexit, I think it would be a mistake to locate the group’s common headquarters in London,” he said.
To assuage concerns from its local regulator, Deutsche Börse repeatedly tried to put the headquarters decision on the agenda for the companies’ joint referendum committee. Its efforts were rebuffed by the LSE, which was steadfast that the terms of the deal were set. Any change meant another shareholder vote.
Tensions rose as the two companies fought over the terms of the sale of the LSE’s French clearing arm LCH to Euronext, their much smaller French rival, for €510m. The move was intended to appease Brussels’ concerns about their combined strength in fixed income clearing, the process through which trades are risk managed.
As the authorities began to test the effect of the disposal in the market last month, it was clear this was not going to be enough.
Euronext voiced concern that trades that normally flowed into the clearing house from LSE-Deutsche Börse businesses could be redirected back into operations owned by the combined group.
The relationship soured further after the allegations against Mr Kengeter.
In a private email to the Germans, chairman of the LSE, Donald Brydon, said some of his consultants had questioned whether Mr Kengeter was a fit and proper person for such a high-profile role, according to two people with knowledge of its contents. Joachim Faber, Deutsche Börse’s chairman, responded that a man was innocent until proven guilty.
Deutsche Börse, which strongly backs Mr Kengeter, said the dealings were related to a long-term incentive plan approved by the board and in which Mr Kengeter was required to participate.
This was all about cementing London’s role . . . [Rolet] feels that the Brexiters have blown it up
On February 16, the commission demanded the LSE sell its 60 per cent stake in MTS and gave the exchange a deadline of February 27. The request was unforeseen by either board or the army of banks and lawyers who stood to share a projected €340m if the deal completed — and the already rocky relationship between the two companies foundered.
For Deutsche Börse, it was a minor issue — “a baby step” said one senior executive — and its board viewed MTS as entirely divestible.
But that was not the perception at the LSE, whose Borsa Italiana operation accounts for around a quarter of adjusted profit.
The UK group felt the request was at the eleventh hour, had an extremely tight deadline and was disproportionate. “We had no idea,” said one adviser who worked on the deal. “It was a bolt out of the blue.”
In an intense week of discussions with the Italian regulators, advisers wrestled with their options. One possible remedy put forward by the LSE was rejected by the commission.
A letter from LSE’s lawyers, Freshfields Bruckhaus Deringer, to the commission on February 23 raised concerns that there may be no legal basis for the divestment demand.
A senior official at the Italian finance ministry, who declined to be identified, said: “We were indeed surprised that the commission was asking for divestment of MTS. But we didn’t take a view. We never received a formal request to do so from the LSE.”
For some EU insiders there was a naivety from the LSE about the commission’s process. One Brussels lobbyist received a phone call for advice from an LSE representative only two weeks ago, who admitted to a lack of understanding of politics in the European capital.
The LSE made it clear it was highly unlikely that it could sell MTS, even if it committed to doing so. It warned that offering the remedy would jeopardise its relationship with Italian regulators and hit business.
Others dispute that interpretation. “It sounds to me ridiculous that they didn’t sell it to please the Italian regulators,” said Gianluca Garbi, chief executive of Banca Sistema and the former chief executive of MTS until 2007. “The Italian regulator would be very pleased for it to be sold back to Euronext.”
One Deutsche Börse executive said talks degenerated only in the final few days. “I think the political noise in the UK was a big factor,” he said.
Thomas Schäfer, finance minister of Hessen, the German state in which Deutsche Börse is based, agreed: “My impression is that in refusing to sell MTS the LSE was looking for, and found, an excuse to be able to get out of the deal without losing too much face and to put the blame on Brussels,” he said. He added that a headquarters switch to Frankfurt was “the more economically and legally sensible option.”
Mr Rolet, who had been due to step aside if the deal went ahead, said on Friday it was not a “nationalism-fuelled project”.
But he added: “It looks like my retirement has been postponed.”
Additional reporting by Arash Massoudi, James Shotter and Rochelle Toplensky
