One month ago, Hong Kong Exchanges & Clearing Ltd.'s (HKEX's) proposal to merge with London Stock Exchange Group PLC (LSEG) took the market by surprise. Its decision this week not to proceed with a firm offer is less surprising. It comes amid resistance by LSEG's board, a presumably lukewarm reception from LSEG shareholders, and understandable investor concerns that any deal would be torpedoed by one or more governments on national-interest grounds. If the deal had gone through, it might have spurred a wave of similar deals, like the chain reaction of activity we saw in 2007 and 2011. For now, however, it seems that global M&A remains unfashionable in the financial market infrastructure (FMI) industry.
The two parties will now pursue their separate paths. For HKEX, its "China Anchored, Globally Connected and Technology Empowered" strategy would see it reinforce its position as a leading global venue for capital raising and the pre-eminent channel for capital market investment flows into and out of China. For LSEG, its strategy increasingly marries solid organic growth opportunities with its big thinking on data and redefinition of what "market infrastructure" means in the future. All eyes remain on its mega-merger with Refinitiv—a bold transaction, warmly welcomed by most shareholders, that would see it temporarily countenance significant financial leverage to bridge into the parallel information services industry.
The HKEX proposal raised an important latent question for the industry--how to best link up investment pools across the major global financial centers, particularly the mainland Chinese stockmarkets. At an aggregate $8 trillion these rank second globally by market capitalization, though remain distant to the huge $34 trillion U.S. market. For now, HKEX remains a key gatekeeper and conduit via its Stock and Bond Connect links into the Chinese exchanges. London and Deutsche Boerse offer alternative visions: London has direct links to Shanghai via the cross-issuance of depository receipts and Deutsche Boerse operates the China Europe International Exchange joint venture with two Chinese exchanges, but for now activity remains low. The slow-moving and unresolved question of connecting investment pools persists, not least given the very gradual moves to ease Chinese capital controls. The current set up looks likely to remain for many years to come.
Cross-regional acquisitions of trophy assets remain politically charged. They might yet happen, but we consider this unlikely in the coming years. Instead, we expect a continuation of the trends that have been shaping the FMI industry over the past several years--solid organic growth in faster-growing, developing economies, gradual in-market consolidation in mature economies, and acquisitions in high growth segments for those that can afford it.
Acquiring Trophy FMI Assets Remains An Uphill Task
Whereas clearinghouses are arguably the most systemically important FMIs given their critical role as the market's counterparty, stock exchanges remain of special interest to governments. Central to their financial ecosystem, they embody capitalism, and every capitalist economy has its own one.
Cross-border acquisitions are sometimes permitted (NYSE/Euronext in 2007, Nasdaq/OMX and LSEG/Borsa Italiana both in 2008) as is some consolidation (Euronext being the original and still vibrant European example). However, over the past decade there have been more failed deals (DBAG/LSEG several times, with DBAG/NYSE Euronext, ASX/SGX and LSEG/TMX all in 2011) than successful ones. Indeed, the only successful cross-regional examples (HKEX/LME and SGX/Baltic Exchange) were in less politically sensitive asset classes (metals and freight). LSEG CEO David Schwimmer said in June this year, "It's hard to think about doing big cross-border exchange-type transactions. It just feels difficult for the industry." While other considerations played a leading part in its decision, HKEX would have had to overcome these political hurdles to get a deal over the line.
Solid Fundamentals Remain, But Mixed Fortunes Lie Ahead
Generally, we see FMIs as providers of investment, risk management, and data services. Their key disciplines are the creation of standardized, reliable investment product, the maintenance of resilient and flexible technology, and the provision of fast, reliable data. It remains a great business to be in for FMIs' equity and debt investors alike: highly cash-generative, typical 43%-66% EBITDA margins (and sometimes higher), defendable market positions (aided by regulation and investors' imperative to interact where liquidity pools most strongly), and fairly resilient through the cycle earnings. S&P Global Ratings continues to see this industry as an 'AA'/'A' one (for the major players) before significant leverage is added.
However, the industry's focus has changed markedly over the past five years. In faster-growing markets such as Brazil and Hong Kong, we see still robust, though cyclical, growth opportunities in equities and fixed income (cash and derivatives). In Europe and the U.S., stock-market capitalization remains buoyed by cheap money. However, these markets have irreversibly fragmented, and growth opportunities are now quite limited for many traditional FMIs. With some exceptions such as NASDAQ, new listings have stalled or are declining, trading volumes are under increasing pressure as tighter regulation curtails banks' ability to intermediate flows, and lower-for-longer interest rates and low volatility are impeding trading activity. Some derivatives exchanges, like CME, remain huge magnets for activity on their marquee contracts, but the development of golden eggs (new, highly popular, and profitable derivatives contracts) remains rare.
So If Not Global M&A, Then What?
European and U.S. FMIs remain positively exposed to cyclical upside if interest rates normalize, economies strengthen, and volatility becomes persistent rather than sporadic. Though volatility might rise, we expect none of these tailwinds to arrive anytime soon--indeed risks are stacked in the opposite direction. These FMIs will likely show high resilience even in a cyclical downturn, probably even more so than during the financial crisis, but growth from traditional channels will become harder to achieve.
The good news is that several strong secular growth trends have provided ample growth opportunities for those able to seize them. This will likely continue irrespective of the cyclical outturn. Furthermore, some of these trends offer a route to increase, sometimes dramatically, the weight of the industry's annuity-like revenues, away from its traditional substantial reliance on volume-driven earnings. They have also allowed some true geographic diversification of earnings, without offending perceived national interests.
FMIs' ability to seize these opportunities has been a function of incumbency or existing strengths and capabilities, strategic thinking, and investment capacity. Size and leverage appetite also matter, for this is a hugely acquisitive sector where the deepest pockets tend to win the battle for assets that trade on high multiples.
More than most, LSEG and ICE have ridden this wave--marrying a stream of acquisitions centered on indices, data, and (for LSEG) clearing to show strong growth in earnings and capitalization and greater diversification. For the first time, and due to its now market-leading earnings multiple, LSEG now has larger capitalization than Deutsche Boerse, and ICE now sits alongside acquisition-shy CME and HKEX as the global big beasts (in market cap terms). We recognized LSEG's strong track record and disciplined leverage appetite when we upgraded the company in May 2019 (see "London Stock Exchange Group PLC Upgraded To 'A/A-1'; LCH Ltd. And LCH SA Upgraded To 'AA-/A-1+'; Outlook Stable"). Assuming that the Refinitiv deal completes, we would expect to lower our ratings on LSEG (and its LCH subsidiaries) due to the associated sustained rise in leverage, but we anticipate that its good track record on post-acquisition integrations will help to mitigate related execution risks (see "London Stock Exchange Group PLC, LCH Ltd, And LCH S.A. Ratings Placed On CreditWatch Negative On Proposed Refinitiv Deal," published Aug. 1, 2019).
For traditional, often smaller, players in slower markets like Europe, strong earnings growth is harder to find. In a largely fixed-cost business, operating expenses cannot be easily cut--though Euronext has been remarkably successful in reducing costs and improving its EBITDA margin ever since ICE divested it after its 2013 acquisition of NYSE. LCH too has become far more efficient in recent years thanks to cost-saving initiatives and strong revenue growth.
Already a product of regional consolidation itself in 2000, Euronext has recently acquired the Irish Stock Exchange and Oslo Bors. In-market consolidation has also been a feature in the U.S. (CBOE/BATS, NASDAQ/ISE, ICE/NYSE), Brazil (B3/Cetip), Russia (MICEX/RTS) and Japan (Tokyo/Osaka). While not rapid, it will likely continue, as long as shareholders and national authorities appreciate the benefits, and increasing imperative, of greater scale.
By contrast, it remains rare that the major players make divestments. Deutsche Boerse sold ISE, its underperforming U.S. stock options business in 2016, but since reinvested in GTX and Axioma. SIX Group sold out of its STOXX and Eurex joint ventures with Deutsche Boerse, and recently folded its payments business into Worldline, though it continues to hold a sizable stake.
- Bulletin: Hong Kong Exchanges' Surprise Merger Offer To London Stock Exchange Group Has No Immediate Rating Impact, Sep. 11, 2019
- Bulletin: Refinitiv Ratings Not Immediately Affected By Hong Kong Exchanges' Merger Offer To London Stock Exchange Group, Sep. 11, 2019
- London Stock Exchange Group PLC, Aug. 28, 2019
- London Stock Exchange Group PLC, LCH Ltd, And LCH S.A. Ratings Placed On CreditWatch Negative On Proposed Refinitiv Deal, Aug. 1, 2019
- U.S. FMIs Should Be Resilient Despite A Tough Start To The Year, But Regulation Could Pose Challenges, Aug. 1, 2019
- London Stock Exchange Group PLC Upgraded To 'A/A-1'; LCH Ltd. And LCH SA Upgraded To 'AA-/A-1+'; Outlook Stable, May 21, 2019
- Financial Market Infrastructure Players Are Greedy For Growth Yet Leverage Appetite Remains Restrained, Aug. 29, 2018
|Selected FMI industry M&A transactions in the past decade|
|Target||Line(s) of business||Domicile||X-border?||Year announced||Acquirer||Approx. consideration ($ mil).|
|Chi-X Europe||Trading (cash equities)||UK||Y||2011||BATS||300|
|Direct Edge||Trading (cash equities)||US||N||2013||BATS||N.A.|
|BATS||Listing, trading (equities)||US||N||2016||CBOE||3,200|
|NEX Group||Trading (bonds, FX), data||UK||Y||2018||CME||4,774|
|EEX / Powernext||Trading/clearing (energy, emissions)||Germany||N||2011||DBAG||N.A.|
|GTX ECN platform||Trading (FX)||US||Y||2018||DBAG||100|
|Irish Stock Exchange||Listing, trading (equities, bonds)||Ireland||Y||2018||Euronext||174|
|Oslo Bors||Listing, trading (equities, bonds), CSD||Norway||Y||2019||Euronext||762|
|London Metal Exchange||Trading & clearing (metals)||UK||Y||2012||HKEx||1,714|
|Climate Exchange PLC||Trading (energy, emissions)||UK||Y||2010||ICE||483|
|NYSE Euronext||Listing, trading, clearing, CSD||US||N||2013||ICE||8,200|
|Interactive Data Corp.||Data/indices||US||N||2015||ICE||5,200|
|BAML Index business||Indices||US||N||2017||ICE||N.A.|
|Borsa Italiana||Listing, trading, clearing, CSD||Italy||Y||2008||LSEG||1,788|
|Turquoise §||Trading (cash equities)||UK||N||2008||LSEG||7,650|
|TMX bond indices||Data/indices||Canada||Y||2013||LSEG||88|
|Citi FI indices / The Yield Book||Data/indices||US||Y||2017||LSEG||685|
|RTS||Listing, trading (equities)||Russia||N||2011||MICEX||N.A.|
|OMX||Listing, trading, clearing||Sweden||Y||2007||NASDAQ||2,530|
|Boston SE||Trading (options)||US||N||2007||NASDAQ||61|
|Philadelphia SE||Trading (options)||US||N||2007||NASDAQ||652|
|NordPool||Trading & clearing (energy, freight, salmon)||Norway||Y||2010||NASDAQ||238|
|ISE||Trading (stock options)||US||N||2016||NASDAQ||1,100|
|TIO Networks||Payment processor||Canada||Y||2017||PayPal||228|
|iZettle||Payment technology and solutions||Sweden||Y||2018||PayPal||2,200|
|Baltic Exchange||Trading (freight)||UK||Y||2016||SGX||87|
|Cetrel SA||Payments processing||Luxembourg||Y||2008||SIX||N.A.|
|Swiss Euro Clearing Bank||Payments processing||Germany||Y||2018||SIX||N.A.|
|Osaka Securities Exchange||Trading & clearing (derivatives)||Japan||N||2011||Tokyo SE||1,209|
|VISA Europe||Card schemes||UK||Y||2016||VISA||23,256|
|Source: S&P Global Ratings. Consideration converted using midpoint rate effective Oct. 9, 2019 (source: oanda.com). N.A.--consideration remains undisclosed. # Acquisitons were for a residual 50% stake not already owned. §Acqisition of 60% stake. **Acquisition of initial 58% stake. LSEG has since acquired a further 25% in several tranches.|
This report does not constitute a rating action.
|Primary Credit Analyst:||Giles Edwards, London (44) 20-7176-7014;|
|Secondary Contacts:||Thierry Grunspan, New York (1) 212-438-1441;|
|William Edwards, London (44) 20-7176-3359;|
|Research Contributor:||Fabrizio Serafini, London;|
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