Brexit casts a cloud over London Stock Exchange-Deutsche Börse tie-up

Leafing through notes of conversations down the years with senior people at the London Stock Exchange, what shines through is that — although two attempts to combine with Germany’s Deutsche Börse failed around the turn of the millennium — the desire for a successful completion never really went away, and remained the long-term strategic objective of both managements.

It was not that the LSE did not enjoy its independence but it took the view that ultimately it might be unsustainable — or at least incompatible with the desire to remain a serious force in global markets. As time went on, an independent London was likely to struggle to find the resources to service ever larger and more active global clients working in global markets. It sensed it would almost inevitably lead to a hostile bid from one of the big American houses — ICE or the Chicago Mercantile. This was not paranoia: Nasdaq gave ample warning of what was likely to come when it made an ultimately unsuccessful run.

But the London executives also knew that a deal with Deutsche Börse would not be acceptable to the London-based financial community and its shareholders unless it fulfilled two key criteria. The first was that it should be presented as a merger of equals. The second was that the combined group had to be headquartered in London rather than Frankfurt.

The obstacle to the completion of such a deal was that Deutsche Börse was several times bigger than the London Exchange, and the German financial community did not want to see it move to London. So nothing happened for years. But then along came Xavier Rolet who, as chief executive of the London Stock Exchange, was in a different league to many who had filled the post.

In a relatively short time, he put together a series of acquisitions that massively increased the value of the London-based group. Meanwhile, coincidentally, the market capitalisation of the German exchange fell. Thus for a brief period earlier this year the stars were in alignment. For the first time in decades, the two groups were of roughly equal value, the outline of a deal was struck and the Germans, in return for agreement, conceded that the new business should be run from London.

With the failure of the Americans to launch a counterbid, it has looked increasingly as if it would move to completion without a hitch — with London’s shareholders due to vote on it officially next week. But now at this late stage, last week’s EU Leave vote threatens to change the dynamic. This is partly because it has sent the London share price into a tailspin, so the two parties are now a lot less equal than they were, but more because it reopens the debate about location.

On the German side, the State Parliament of Hesse, which covers Frankfurt, has to consent. They are well aware in Frankfurt that London dominates European financial markets. They understood, too, that the long-running moves towards EU capital markets union would most probably add further to that dominance. So they have understood even if they do not particularly like the logic of a London location.

But the Brexit vote changes things because, if it is followed through, it means that Europe’s leading stock exchange and main capital-markets engine will be housed outside the European Union.

The German politicians and its financial regulator are understandably at a loss to see how this can work. It does not seem tenable that a deal designed to strengthen the EU’s capital-market infrastructure so that it can compete more effectively in the world should be outside the Union and operating in what will probably become an increasingly different regulatory, tax, legal and currency regime.

Both sides have said the Brexit vote makes no difference and they will press ahead with the deal. Brave words but, in the current circumstances and with the political tides swirling the way they are, the evident willpower and determination of the leaders on both sides may still not be enough.