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Regulators crowd round Hong Kong Exchanges' LSE merger proposal

The U.K. government has described London Stock Exchange Group PLC as a "critically important’" part of the financial system, as analysts said Hong Kong Exchanges & Clearing Ltd.'s plans to acquire it would face intense scrutiny from an array of regulators.

HKEX's £31.6 billion proposed offer to acquire LSE has been rejected by the British stock exchange company, but HKEX is continuing to woo LSE shareholders and is expected to return with another offer. Numerous attempts by exchanges have foundered in recent years as regulators blocked deals on antitrust grounds or on wider political concerns.

The U.K. Treasury said today that it is keeping a close watch on proceedings.

"Given the London Stock Exchange Group is a critically important part of the U.K. financial system, the government is following the situation closely, and is in touch with both parties," said a spokesman.

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This follows comments from Business Secretary Andrea Leadsom, who said the government would "look very carefully at anything that had security implications for the U.K." in relation to the proposed takeover.

Financial Conduct Authority CEO Andrew Bailey said Sept. 16 that the regulator was "in close touch" with both parties, though he stressed that the regulator had not yet formed a view of the proposed deal.

LSE highlights regulatory risk

LSE Chairman Don Robert highlighted in his letter rejecting the proposal the risk that regulators in various jurisdictions would scrutinize any bid intensely, casting doubt on the chances that any transaction would be successful.

He cited the U.K. Enterprise Act, which allows the government to intervene in mergers if there is a "public interest consideration" which can be related to national security or financial stability. In the U.S., Robert said, any deal would face scrutiny from the Committee on Foreign Investment in the U.S.

Robert also cited Italy’s "golden powers" as a regulatory issue. LSE owns the Milan stock exchange, Borsa Italiana, and the Italian government has said it considers the exchange to be a strategic asset. Under new powers expected to be brought in Sept. 19, it will reserve the right to intervene in any potential sale of the exchange to a non-EU company.

Analyst concerns

Analysts have also raised concerns over whether the deal would win regulatory approval.

"We remain concerned about the high risks to the deal, particularly across cross border exchange-to-exchange M&A," analysts at Citi said. "Even if the LSE board approves the deal, satisfying the regulators would be a challenging task, in our view."

They said LSE's own $27 billion bid to acquire financial data provider Refinitiv US Holdings Inc. was likely to face less onerous regulatory scrutiny.

Analysts at Exane BNP Paribas also drew attention to the political risks surrounding the deal.

"We think the high level concept of China 'owning' assets such as U.K. and Italian cash equity trading and custody of Italian bonds may prove to be politically sensitive, particularly in the broader current market backdrop of Hong Kong/China and U.S./China tensions," they said.

Analysts at Redburn also said the foremost uncertainty attached to the HKEX proposal was the political and regulatory risk.

They said scrutiny from the U.S. may be even more problematic, given that LSE's LCH business is the dominant clearing house for the vast over-the-counter U.S. dollar interest rate derivatives market.

The LSE operates businesses that are regulated by the Securities and Exchange Commission, the Commodity Futures Trading Commission and FINRA, but it is the Committee on Foreign Investment in the U.S. which examines politically sensitive takeovers.