The Economic Effects of a Merger of Deutsche Börse and London Stock Exchange

Economic prosperity and growth depend on the efficient allocation of savings and investment. Integrated and highly liquid financial markets provide access to a variety of financial instruments for the corporate sector and enable efficient risk diversification for investors and savers. Liquid and stable financial markets are needed in order to achieve an efficient price discovery for stocks, bonds, foreign exchange as well as for derivative contracts. In this study, we analyse the proposed merger of Deutsche Börse Group and London Stock Exchange Group in light of its contribution to improve these prerequisites for economic prosperity and growth.

The EU has traditionally a bank-based financial system in which capital market activity, like stock and bond issuance, concentrates on its largest corporations. During the global financial crisis and the banking and sovereign debt crisis in the Eurozone even very profitable companies suffered from a restrictive access to finance when their banks got into distress, while companies which had access to capital markets were less affected by the crises. A crisis lesson was that companies funding will improve through a better access to capital markets in addition to the financial intermediation through banks. Deeper and more liquid capital markets will provide companies with a larger pool of financing options. The primary market for listed stocks is an important source of capital for financing long-term investment projects. The proposed merger will increase the liquidity of the market and thereby attract investors. Investments become less risky for investors when liquidity is high because liquidity ensures that orders can always be executed at attractive and undistorted prices. Moreover, a larger and more liquid stock market with access to UK’s financial capital will be beneficial for German companies through an easier access to a larger international investor base.

A second consequence of the financial crisis was that European capital markets became fragmented along national borders. Cross-border bank lending and investment broke down. The European Commission’s action plan for a Capital Markets Union is a step in the right direction. Reviving financial market integration, fostering cross-border investment and cross-border asset holdings is urgently needed. A merger of Deutsche Börse Group and London Stock Exchange Group would be beneficial to EU companies and to this political project because it would provide the EU with a large and highly liquid financial market infrastructure, which covers different countries. The merger would help to integrate and consolidate the nationally fragmented system of exchanges, clearing systems and securities depositories. The consolidated system would foster the price discovery process towards more informational efficiency, it would increase liquidity and thereby attract international investors. Increasing the investor base would be beneficial for the EU because it would increase cross-border asset holdings and thereby foster risk-sharing in case of country-specific shocks.

The UK households hold financial assets in the amount of 193 percent of the UK’s GDP in pension funds and insurance contracts, while UK financial companies hold assets summing up to 1.400 percent of the UK’s GDP. German companies will benefit from the proposed merger through a better access to UK’s financial capital. German savers might also benefit from a merger between Frankfurt and London by having access to a large, diversified and liquid stock market. Although German savers preferred investing in highly liquid bank deposits in the past, they could improve their savings decisions in the current low interest rate environment by holding a higher fraction of their wealth in form of a well-diversified stock portfolio which yields a higher expected return compared to deposits, while also being highly liquid.