Page 183 - DCOM510_FINANCIAL_DERIVATIVES

Financial Derivatives

Notes and operation of IT solutions for financial markets and market participants. Through a
joint venture with Stockholmsboursen, the LSE also operates a small derivatives exchange,
EDX London (EDX). The total turnover of the LSE in the financial year ending 31 March
2004 was approximately €250 million.
Transaction

On 20 December 2004 Euronext announced that it was considering making a cash offer to
acquire the LSE, following a similar announcement by Deutsche Bourse AG (DBAG) on 13
December 2004. Euronext publicly reconfirmed its interest in a possible cash offer on 27
January 2005 and announced key elements of its potential proposal on 9 February 2005.
(Elements of this proposal will be discussed at various points below.)
The proposed transaction was notified to the Official Fair Trade (OFT) on 28 January 2005.
The OFT’s administrative deadline for a decision is 29 March 2005.

Jurisdiction
As a result of this transaction Euronext and LSE will cease to be distinct. The UK turnover
of LSE exceeds €70 million, so the turnover test in section 23(1) (b) of the Enterprise Act
2002 is satisfied. The OFT believes that it is or may be the case that arrangements are in
progress or in contemplation which, if carried into effect, will result in the creation of a
relevant merger situation.
Assessment
Euronext’s proposed bid is one of two competing offers to acquire the LSE; the other is
from DBAG. The OFT has considered each proposed offer on its merits. This has necessitated
consideration of the prospects for competition in listing, equities trading (on-exchange
trading services, clearing and settlement), derivatives trading and information services.
In respect of listing, settlement, derivatives trading and information services, the OFT has
identified no evidence that the merger would substantially lessen competition. The focus
of this decision has therefore been on equities trading.

Competition to provide on-exchange trading services for equities in the UK (and indeed
elsewhere) can be best be described as episodic. Episodes that appear to have prompted a
competitive response from an incumbent exchange are characterised by a sufficiently
credible threat (e.g., because of a better technology offering, lower prices or customer
support) that liquidity might switch from one trading platform to another. Recent
competition in the Netherlands among Euronext, the LSE and DBAG, and Euronext’s
contemplation of UK entry are consistent with this conclusion. It may be the case that the
prospect of such competition in the UK acts as a stimulus to LSE at present, or has the
potential to do so in the future. The current importance of Euronext in this regard is
uncertain, and the potential threat from Euronext may not be unique. However, historic
episodes of competition may not be a good guide to evolving competitive dynamics in
this sector, so that the OFT considers that the evidence should be assessed with caution.
While Euronext’s arguments have merit, on balance and in light of all of the evidence, the
OFT considers that the merger may eliminate important potential competition between
the LSE and Euronext in respect of on-exchange trading of equities in the UK.
In respect of clearing, the OFT doubts there is a realistic prospect of a post-merger substantial
lessening of competition. While the impact of Euronext’s proposed corporate governance
arrangements is difficult to predict, it remains the case that any financial benefit derived
by Euronext from LCH’s performance of the clearing function is small relative to LSE’s
trading revenues and the potential impact of higher clearing fees on levels of trading.
Such dividend payments alone are therefore to be unlikely to be sufficient to incentives
Euronext to end contestability of the clearing contract.
Contd....

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